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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day, and welcome to the SAP Q2 2022 Earnings Conference Call. Today's conference is being recorded.
At this time, I would like to turn the conference over to Anthony Coletta, Chief Investor Relations Officer. Please go ahead, sir.
Thank you, and welcome, everyone. Thanks for joining us today on our earnings call to discuss SAP's Q2 and first half 2022 results. On our Investor Relations website, you can find the deck supplementing today's call.
With me today are CEO, Christian Klein; and CFO, Luka Mucic, will make opening remarks. Scott Russell, who leads our Customer Success organization, is also with us for Q&A.
Now let's do the safe harbor. During this call, we'll make forward-looking statements, which are projections or other statements about future events. These statements are based on current expectations, forecasts and assumptions that are subject to risks and uncertainties that could cause actual results and outcomes to materially differ.
Additional information regarding these risks and uncertainties may be found in our filings with the Securities and Exchange Commission, including, but not limited to, the risk factors section of SAP's annual report on Form 20-F for 2021. Unless otherwise stated, all financial numbers on this call are non-IFRS. Growth rates and percentage point changes are non-IFRS year-over-year at constant currencies. The non-IFRS financial measures we provide should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with IFRS.
And with that, I'd like to turn it over to Christian.
Yes. Thank you, Anthony, and thanks to all of you for joining today. This has been a good quarter for SAP despite the challenging political and macroeconomic environment. Our cloud and total revenue have exceeded market expectations and are progressing faster than we expected at 34% and 13% nominal, respectively.
Our top line cloud performance is clearly ahead of plan, further accelerated by the current macroeconomic environment and currency tailwinds. Customers are actually turning to us now more than ever to help them address their most pressing concerns, business model transformation and process automation, supply chain resilience and sustainable operations. We see demand for SAP technology continuing to increase with an increased focus on transforming and automating mission-critical business processes and the core functions of an enterprise.
As we have seen in previous economic pullbacks, companies that balance cost efficiency measures with strategic investments in technology are more resilient and better able to offset margin pressure. We are also seeing a powerful snowball effect from our platform and ecosystem businesses as the adoption of SAP solutions accelerates.
Let's take a look now at some of our top line numbers for Q2. In Q2, we hit the major milestone of cloud revenue becoming our largest revenue stream for the first time. Cloud revenue was up 24% at constant currency and up 34% at nominal levels. Current backlog growth accelerated at 25% and now exceeds €10 billion, another first.
Current cloud backlog for SAP S/4HANA hit a record 87% growth and stands at €2.3 billion, driven by continued strong adoption of RISE with SAP. In addition, S/4HANA cloud revenue growth continued to accelerate at 72%. Customers are choosing us for the power of our integrated portfolio. First, core ERP; second, the SAP business technology platform; and third, our best-in-class solutions. Our strategy is focused on investing in and capitalizing on the integration of these assets. This provides unmatched superior solutions for our customers and extensive cross-sell opportunities for SAP.
I'd like to now provide an update on our strategy execution. Since we initiated our transformation almost 2 years ago, our performance is well ahead of plan. SAP has always been acknowledged as the category leader for ERP. Now just as SAP invented ERP decades ago, we are leading the ERP transition to the cloud. This has led to over €2.2 billion of current cloud backlog for SAP S/4HANA, as I mentioned earlier. The momentum we are seeing today increasingly comes from the power of being a platform company. Our business technology platform now has a run rate exceeding €1.4 billion, and there are more than 14,000 customers using the platform.
Turning to our core line of business solutions. They are all growing by double digits in both cloud revenue and current cloud backlog. We see customers increasingly choosing to adopt the full portfolio from SAP given the enhanced value from our integrated solutions. For example, many of our customers opt for our Intelligent Spend solutions to achieve cost savings across their entire direct and indirect spend as well as travel and expense and third-party workforce.
The potential for cross-selling is tremendous. In Q2, we saw was with SAP being a cross and up-sell catalysts with more than 85% of RISE deals, including additional cloud solutions and 77% of RISE customers adopting the SAP business technology platform.
We have also entered key new growth markets, recognizing that no business can succeed in isolation, we pioneered a new approach in building the SAP Business Network. The SAP Business Network allows customers to connect realtime across their suppliers in industry-specific networks. This boosts transparency and provides the resilience so desperately needed in today's environment.
Our new sustainability portfolio complements the SAP Business Network, enabling transparency across value chains, helping our customers to meet regulatory requirements and contribute to a sustainable future. Underpinning this leadership position is our business transformation as a service offering, RISE with SAP. Since RISE with SAP was launched at the beginning of last year, we have seen the offering going from gaining traction, to gaining momentum, to becoming the preferred choice for our customers as they move to the cloud. RISE with SAP helps customers with the hardest part of that transition, redesigning how the companies want. We offer customers so much more than a technology transition. RISE with SAP helps them: first, to redesign their end-to-end business processes; second, transition to a new agile ERP in the cloud; and third, innovate on the platform to design their own custom solutions.
In Q2, RISE customers included Moderna, ABB Information Systems, RWE, HeidelbergCement and Bridgestone. Moderna's pioneering vaccine is helping the world overcome the COVID-19 pandemic. They selected RISE with SAP to support the ambitious growth targets to scalable, automated end-to-end processes across research and development sourcing and distribution and support functions. RWE, the leading German utility company, is adopting wise with SAP to support its international expansion and its sustainability initiatives as part of its growing green strategy.
The success of RISE with SAP in turn for strong performance across our line of business applications, including S/4HANA. We see continued cross- and up-sell momentum, which means we continue to create about 2.5x the value from a customer after they have adopted RISE with SAP. We now have around 20,000 S/4HANA customers, up 15% year-over-year with more than 60% of our customers being net new.
We are also seeing strong momentum for S/4HANA in the cloud, with approximately 6,000 customers and over 600 wins in Q2. We are seeing increasing traction in the mid-market and in the start-up community. For example, the French unicorn, Doctolib is an online and mobile booking platform that helps users find doctors and make appointments. They selected S/4HANA cloud as an easy to implement robust scalable solution providing fast time to value.
Now our order entry growth for S/4HANA cloud and on-premise clearly exceeded 30% demonstrating significant gains in market share. SAP's business technology platform enables customer innovation and infrastructure integration. This quarter, the global leader HeidelbergCement decided to move from their on-premise ERP on Oracle to S/4HANA cloud on Azure. They will be using SAP's business technology platform as an integration and development platform to provide access to SAP services.
Our sustainability solutions have taken on an even more important role given the energy crisis. ERGO Group, one of the largest insurance groups in Europe, has chosen SAP to help them navigate a highly regulated sustainability expectations of the financial services industry, of course, in Germany. ERGO aims to open new sustainable business practices, create climate-neutral business operations and create transparencies throughout its business by reporting in accordance with the international guidelines set out by the GIA.
Our Intelligent Spend and Business Network division has taken on new meaning as companies plan for continued inflationary pressures and a need to diligently manage costs. Wins this quarter include BeiGene, the leading biotech company specializing in anti-cancer drugs. They chose SAP Ariba to quickly build a cloud-based procurement management platform to support different languages and regulations around the world in addition to improving efficiency.
Turning to our customer engagement portfolio. Positivo Tecnologia, a Brazilian technology company, is using SAP CX solutions to automate their marketing campaigns based on customer behavior analysis. This will enable them to personalize their customer engagements and create more opportunities for customer cross-sell, upsell, conversion and retention.
In Q2, ASUS, the global leader in personal computer, monitors, graphics cards and routers chose SAP SuccessFactors to bring its vision for employees to life. The solution will provide a one-stop service supported by data analysis and insights.
SAP Signavio, part of our business process intelligence portfolio, is going from strength to strength. Corning, which is one of the world's leading innovators in material science, selected the full SAP Signavio suite to drive governance and collaborative process management excellence as they transform their ERP systems.
Customers this quarter also include Moët Hennessy and ALTANA, the German chemicals company.
I'd like to spend a little time talking about our outlook. We are entering the second half of the year with a very strong cloud pipeline. Given our strategy maps directly on to our customers' most pressing challenges, we see the shift from CapEx to OpEx spend combined with currency tailwinds completely offsetting the top line impact of our Russia exit.
On the bottom line, we are adjusting our guidance based on 2 onetime impacts: first, our intended full withdrawal from Russia; second, in the current macro environment, our customers are shifting to the cloud faster than expected as they continue to move from upfront capital expansion to recurring operational expenditure. This leads to an additional transactional impact on our short-term profitability with clear midterm upside as our cloud strategy continues to pay off.
We are managing a significant portion of these onetime impacts with additional measures around discretionary spend.
Looking beyond 2022, we are clearly ahead of plan to deliver upon the promise we made in October 2020 when we announced our new strategy. We are confident we will achieve double-digit operating profit growth in 2023 by keeping the promise of flat to slightly declining operating profit through 2021 and 2022 versus 2020. And we are well on track to achieving all the performance goals for our 2025 midterm ambitions.
On the bottom line, the investments we made over the last 2 years put us in a good position to deliver double-digit profit growth starting next year. Very importantly, we also have a strategic initiative in place to consolidate and simplify our portfolio. This will result in increased focus on our core high-growth solutions providing even stronger synergies across our suite of solutions, complemented by potential acquisitions in our core.
We will provide an update on our 2025 ambition in the next quarters once we have more clarity on the macroeconomic situation.
In summary, this has been a good quarter. We made significant investments during 2021 and the first half of 2022, which now enables us to further scale our execution. Our strategy is perfectly aligned to the challenges our customers are facing. And we look forward to helping them come out of the current environment stronger and more resilient.
Thank you again for joining us today. And I will now hand over to Luka to talk through our results in more detail. Luka?
Thank you, Christian. Yes, there are definitely many topics affecting businesses worldwide today and creating a challenging environment. We, nonetheless, as Christian said, delivered a good quarter, proving that our strategy is working and our solution portfolio is meeting customer demand. Our portfolio is more relevant than ever for our customers and the transformation to the cloud continues to deliver them even more exciting opportunities. We're helping them transform their businesses, create more resilient supply chains and accelerate their sustainability efforts.
In the second quarter, we saw robust double-digit cloud order entry growth with a particularly strong momentum in North America and Latin America. The trend towards larger cloud transactions also accelerated, and deals with a volume greater than €5 million contributed 48% to our cloud order entry in the quarter. This was again driven by our RISE with SAP offering.
Christian already talked about our ongoing cloud momentum and the fast accelerating growth from S/4HANA and our business technology platform. To reiterate, we continue driving strong top line growth and cloud revenue became the largest revenue backlog exceeded €10 billion for the first time and was up 25%, accelerating from the 23% growth that we saw in the first quarter. Again, the war in Ukraine had a dampening impact of 1 percentage point on that growth rate.
S/4HANA current cloud backlog was up a record 87% and contributed more than €2.2 billion to the overall current cloud backlog, becoming the biggest contributor. At our financial analyst conference, we introduced a new disclosure to reflect the evolution of our strategy. Our SaaS and PaaS portfolio combined grew an impressive 26%. And breaking it down, SaaS cloud revenue was up 24% and PaaS cloud revenue was up 40%. Strong cloud growth was primarily driven by an outstanding contribution of S/4HANA cloud; Qualtrics, the business technology platform; and SAP Signavio. In addition, we also saw strong double-digit contributions from our other SaaS offerings, including Concur, which continued its path of recovery and grew by 20%.
Fueled by this cloud revenue momentum as well as the strong growth in services revenue, our total revenue was up 5% in the quarter. Our cloud revenue performance was strong across all regions in the second quarter. EMEA increased by 27%, Americas by 22% and APJ by 26%. Germany had an outstanding cloud revenue performance, while the U.S., Brazil, Japan, India and Switzerland were particularly strong.
Let's now take a look at the bottom line, starting with gross margins. Due to revenue mix effects, our total gross margin decreased by 30 basis points to 73%. Very importantly, our cloud gross profit growth of 28% was supported by a continued upward trend of our cloud gross margin. Year-over-year, it expanded by more than 2 percentage points and reached 72%, and that is despite increased investments into our next-generation cloud delivery program. Our non-IFRS operating profit was down by 16% to €1.680 billion, mainly driven by a reduced contribution from software licenses revenue as well as significant bad debt expenses related to the war in Ukraine.
In addition, we incurred restructuring expenses of €130 million mainly due to the exit from Russia, impacting IFRS operating profit, which was down 32% to €673 million. Excluding the direct impact of the war in Ukraine, IFRS operating profit would have been down 3% and non-IFRS operating profit down 10%.
Let me now turn to EPS and cash flow. The decline of earnings per share that you saw in the quarter reflects the contribution to financial income by Sapphire Ventures, which was €1 billion lower than over the same period last year. Our IFRS effective tax rate was up 42.5 percentage points to 62.2%. This was mainly due to the reduction in tax-exempt income contributed by Sapphire Ventures and an additional increase of non-deductible expenses in the context of share-based compensation and restructuring expenses related to the war in Ukraine.
As compared to that, our non-IFRS effective tax rate was only up 10 percentage points to 29.3% as it was unaffected by the increase in non-deductible expenses. Our free cash flow for the first 6 months came in at approximately [€2.81 billion]. The year-over-year decline is mainly due to the reduced profitability in the quarter and impacts from working capital caused by our continuous move to the cloud.
In the second half, however, we expect a more favorable cash flow due to lower cash taxes and increased profitability. We are, therefore, reiterating our free cash flow outlook of above €4.5 billion for the year.
On the tax line, we are updating our full year 2022 IFRS effective tax rate guidance to 34% to 38%. This adjustment mainly results from an updated projection of non-deductible expenses and the lower expected 2022 financial income contribution of Sapphire Ventures, given current market conditions. As the updated non-deductible expenses are not included in non-IFRS, we continue to anticipate a full year non-IFRS effective tax rate of 23% to 27%, but now expect to be at the upper end of this range.
Let's now turn to the outlook. As you've seen in today's release, we are reaffirming our revenue outlook for the full year. We are updating our expected operating profit impact of approximately €350 million from the war in Ukraine and a potential continued market decline of software licenses revenue due to the current macro environment.
Finally, a few words on sustainability and some strategic initiatives. We continue to make progress on the sustainability front as both an enabler and an exemplar. We have the biggest positive impact through our solutions, and we have announced new innovations in the SAP Cloud for sustainable enterprise solution. For example, the enhanced SAP Product Footprint Management solution helps customers reduce product carbon footprints at scale. Further, Taulia announced a partnership with EcoVadis. We will provide ESG ratings for Taulia's sustainable supplier finance solution.
We have also achieved positive milestones around diversity. For example, women in management have increased further to 28.8%. Demonstrating further positive impact, our SAP.iO Foundries has achieved its goal of supporting 200 companies in its portfolio that are managed or founded by underrepresented individuals earlier than expected. So in conclusion, the results of this quarter once again proved that our strategy is resonating, confirmed by our current cloud backlog performance. In our discussion with customers, we are clearly seeing that they look to strategic investments in technology to help them solve their most pressing business imperatives. We are now ready to capitalize on our substantial growth investments over the last 18 months by delivering sustained growth and profitability expansion. This makes us confident that we're making strong progress towards our midterm ambition. And based on our strong cloud momentum and favorable currency development, we expect to provide an update to our ambition in the upcoming quarters.
Thank you, and we will now be happy to take your questions.
Operator, please open the line.
[Operator Instructions] We will now take our first question from Fredric Boulan from Bank of America.
Fred from Bank of America. Two questions, please. One is around what's driving the change around license deceleration. Any specific end markets, size of clients that you can point to? And what has changed versus Q1 when you gave that unchanged guidance considering we already had a fair amount of concern on end markets.
And secondly, if you can touch around pricing. We have a high inflationary environment across your geography. Can you share with us the actions you're taking to pass that on to a degree and if you can split that between cloud maintenance and license?
Yes. So let me first take the question right away on pricing. And indeed, I mean, what we are seeing is also across the world high inflation and, of course, increasing costs. But at the same time, what we're also having a very sticky cloud business. And with that, actually, of course, we will -- we are planning to offset some of these cost increases. We will see with additional price increases. And we are just in the planning for that, and we will release our new price schedule then in the upcoming weeks and months. But definitely, of course, we will and have to react to this inflationary pressure. And maybe, Luka, you can comment on the profit outlook, yes?
Yes, absolutely. So first of all, in terms of the momentum that we are seeing on the software license side, and I will invite Scott also to make some comments around that, I mean, we were always in our planning for the full year. Even under normal conditions, we were assuming a negative software license performance in Q1 given that the prior year Q1 was very strong with double-digit growth. And so that was for us back then not a strong signal of something deteriorating fundamentally. What we see now in Q2 is actually on the one hand a strong acceleration of the transition to the cloud that you see also in the very strong S/4HANA results that Christian has talked about. And that is not to the detriment of the total order entry for S/4HANA as Christian has also said, with clearly more than 30% growth combined across cloud and on-premise, we're clearly gaining market share here. But the shift has become really more pronounced, and that's why we had the decline of 38%.
And it's a combination, I would say, of this accelerating shift because in the current environment, the customer preferences for OpEx versus CapEx investments is clearly further increasing and certainly, in some markets, also macro concerns. Broadly speaking, I would say, and Scott, perhaps you can add some flavor on it. We see a very constructive demand environment in Americas and in Asia. And in Europe, it's a little bit a tale of two cities. The closer you get to Russia and Ukraine or in our Middle and Eastern Europe region there, we clearly see a lower kind of conversion of pipeline to actual closings. In the rest of Europe, was actually a very solid quarter as well, in particular, on the cloud side of the house. So when you take all of this together, indeed, after Q1, we left our guidance unchanged because we were focused on our ability to absorb the impact from the Russia exit as a direct impact.
And when you take a look at that, we have now reduced our guidance for operating profit at the midpoint by €250 million. The impact from Russia is actually €350 million alone. And so we are actually absorbing a good part of that. But you see now the indirect impact of the stronger shift from on-prem to cloud that comes along with it outside of Russia, and that is something that we have now come better to appreciate, and therefore, it made sense for us to derisk the outlook for 2022. But we now feel very confident that this outlook is safe and supports the continuation of the shift that we have seen in the first half to also extend into the second half. Perhaps, Scott, any color commentary around the momentum and also the shift that you're seeing in the market?
Yes, sure, Luka. In addition to what you described around this year from the CapEx to the OpEx and the market conditions, what we've seen in the market since the launch of RISE is the willingness of companies to move their mission-critical workloads to the cloud run by SAP. You now take the current environment, the need of a safe, secure, reliable, scalable platform that allows them to accelerate and grow is more relevant than ever, which means the demand continues to increase for RISE with SAP and S/4 in the cloud. But that correspondingly means the demand, combined with the other factors that Luka described, is reduced. And we can see that as a validation of the strategy and acceleration of the strategy. So whether you're Baker Hughes oilfield or ABB Information Systems or the Defense Logistics Agency or many others, these big organizations, let alone the 60% net new customers, their acceleration to move to a platform that they're looking at not for 1 year, 2 year, 3 years, they're looking 5, 10 years out in their decisions that they're making here and they're looking for that scalable cloud platform, so I see it as a positive, but it is certainly an accelerated shift.
Thank you and we will take the next question please.
Next question from Amit Harchandani from Citigroup.
Amit Harchandani from Citi. Two questions, if I may. My first question is with regards to the cloud momentum in the context of macro. Now you've talked about obviously strong secular drivers underpinning your portfolio. But if there was to be a stronger recession going into 2023, do you have any views on how do you think your cloud growth is likely to trend? What is the sort of discussions you're having with customers? Yes, they see a need for it today, but do you see that changing going forward? And the reason I ask this is because typically in the past recessions that we have had, cloud was a small part, so would be keen to know your thoughts on the same.
And the second question I have is with regards to your operating margin performance. We have seen 2 quarters in a row where the strength in the cloud seems to have been offset by weaker-than-expected operating margin outcome. Can you talk about what drove it on the OpEx side, particularly the sales and marketing expenses? And if you see merit in potentially giving better maybe quarterly guidance on operating margins as we go forward to reduce this lack of understanding.
Yes. So let me take the first question on the outlook for cloud for the second half, but also for 2023. And of course, when you have conversation these days with our customers, I mean, first, what we clearly can confirm is that our cloud pipeline compared to 3 months ago actually increased. So we see stronger demand. And why is that? It's not necessarily only the move to the cloud. When you talk about SAP and when you talk about RISE with SAP, it's about is the CEO willing now to stop the business transformation of a car manufacturer or a retailer of utilities. The answer is clearly no. They want to continue full speed to build more resilient digital business models when it comes to new license model, when it comes to more intelligent pricing, quoting, when it comes to reskilling the workforce, this is all SAP. This is all RISE with SAP and there's no slowdown.
The second one, of course, when you look into our portfolio and into the pipeline, oftentimes these days, companies see less of a demand challenge but a huge supply chain challenge. So also there, it comes to a resilient supply chain. So SAP Business Network, what can we do with IBP with our leading supply chain solutions to make these supply chains more resilient. So also there, the pipeline is up.
And then when you -- utilities, oil and gas and others, of course, everyone wants to also transform into a more sustainable enterprise. And there, we have new technology. We're offering a green letter and also that is of high demand. So when you would ask me today, we see a very robust pipeline. I see also no signs of a slowdown in the cloud with regard to our SaaS portfolio, with regard to our PaaS portfolio. So on that side, we are very confident.
And perhaps just to complement this with 2 factors, let's not forget that many of SAP's stronghold industries, I think, will not so much be subject to recessionary risk. I mean we have the E&G industries, obviously, as a stronghold. We have pharma as a stronghold with Moderna, what we have seen now we have all of the others essentially as well. We have retailers a stronghold. So I think that gives us also good support in addition to the strength of the portfolio. And the other point is the backlog as well. I've talked about, I think, now for a number of quarters, not only do we see a significant sure in our current cloud backlog and the continued strength there. We actually had significantly higher growth rates in terms of cloud TCV and then the annualized contract values for a long time now since the advent of RISE with SAP. And so this gives us already a very strong coverage through what we have contracted and what will come in guaranteed into the current cloud backlog of future quarters and, of course, also into the revenue line. And that's an additional safety net that you don't necessarily already see in the current cloud backlog.
Now quickly on your operating margin topic, I think that's a valid point. But we have started actually since the beginning of the year, I've already given some commentary around seasonality, including actually also the impact that we have to expect for from Russia in Q2. And I'm happy to expand on this. First of all, in the quarter, in the first half year, you're absolutely right, the sales and marketing ratio has been significantly up. Why? Because we have front-loaded investments, and we were always clear about that. I said that on the Q4 call that we have to expect negative profitability in the first half and then improvements in the second half year. You want to actually have your territories covered so that you can drive for the strong growth that we have expected, and that's exactly what has happened. So we added almost 3,800 hats on the go-to-market front year-over-year in the first half year. And obviously, that comes with incremental expenses, but that was planned and that will actually moderate in the second half year. And certainly for 2023, we expect a further reduction in the sales and marketing ratio.
Let's also not forget that COVID is pretty much behind us when it comes to customer engagement. So on the marketing side of the house, we have returned to physical events. With Sapphire coming back, yes, it costs a bit more than a purely virtual event, but I can ensure you that it also drives significantly more pipeline. And so from that perspective, that's a worthwhile investment that we see -- we will see the payoff on with the continued momentum on the revenue front.
So I think it's important that I use this opportunity to give you then also some more color commentary around how you should think about the second half year. I mean on the CCB and on the cloud revenue side, it's essentially pretty much what I shared also as expectations in our Q1 call and after Q4. So we continue to believe that we will exit the year with a CCB growth rate that is similar to the one that we saw in Q4 2021. I'm also reasonably confident that we'll be able to absorb the impact of Russia as a part of that. And it should be a pretty steady road from here on that we see in the second half year.
On the cloud revenue front, it's quite similar. So you should expect a quite stable growth from what we have seen in Q2 as well, and there is a difference on the operating profit line. So in Q3, we're still expecting negative operating profit and then a return to positive operating profit in Q4, making them the room for the return to double-digit growth in 2023.
Why is that so? Well, first of all, because as we said, the front-loaded investments that we made means that we will start to scale profits, in particular, towards the end of the year. We will have really digested the impact of the war in Ukraine in Q4. In particular, we will have released most of the employees that we still retain in Russia by then. And that will, of course, be released on the operating profit line as well. The comparables on the expense side will become a lot easier because last year, Q4, we had already very significant hiring and significant investments in pipeline generation and so on as well as we anticipate a close of our pending divestiture in Q4. And that will, of course, provide help. Please remember last year, we had the Fioneer joint venture set up in Q3. And of course, we don't have a comparable event in Q3 of this year. Hopefully, that helps to understand the dynamic a bit better.
Thank you. Next question please.
Next question from Adam Wood from Morgan Stanley.
Just first of all, maybe on the assumptions for the second half on the profitability side. I mean you've alluded to the shift to cloud and macro having an impact. Are you basically assuming a continuation of the situation in the second quarter, i.e., a little bit of weakness in parts of Europe, hitting the licenses and that continued cloud strength also impacting licenses for the second half? Or have you also made the assumption that is more macro cycles go, that weakness could spread to other parts of Europe and maybe to other parts of the world on licenses and so there's a little bit of incremental caution? So just in terms of what you're assuming, particularly on the macro side for the second half of this year.
And then maybe secondly, as we look forward into next year, again, I think most investors I speak to are expecting a recession or certainly a slowdown. Could you maybe just talk a little bit about how you would manage the cost through that, maintaining investments versus, as you say, already starting to focus on discretionary spend? And is there a level of growth where it would be impossible for you to grow EBIT double digit next year as the current guidance suggests?
Yes. Let me take this. So first of all, on the second half guide, yes, so we -- actually, we don't see the software license to cloud transformation only happening in parts of Europe. This is actually something which is already happening at a global level. And we expect in our guidance that it will continue to happen at the same pace as what we have seen in Q2. And obviously, against this, we're running already with our Cost Flex program and productivity program that you have alluded to. And that, of course, means that we are taking out expenses in discretionary areas. We have already slowed down hiring in Q2. As you have seen with only 600 additions, we will further slow this down. And because we have actually already made significant moves with close to 5,500 additional employees in the last 3 quarters, so we are well set up to continue to capitalize on the growth opportunities without kind of adding on the investment front to the same extent. The only exception here would be the continuation of our cloud delivery harmonization program, which is well underway now. We have a very clear line of sight now that we'll complete in the first half, and then we'll make room to yet another significant step-up in cloud profitability. So from that perspective, we feel that we're appropriately covered, that the guidance is safe now because what we saw in Q2 on the license side was not confined to only parts of Europe, but was actually a broad-based trend that we saw.
And in 2023, look, I mean, we have said that we are committed to a double-digit growth over the 2022 numbers. Because that question might be asked, let me answer it proactively right away. Yes, and that would also include the divestiture. So whatever onetime gain we drive from that in 2022, we would build off the double-digit growth for 2023 on that basis. Frankly, we see ourselves set up very well with the investments that we have made now. We certainly don't see the need for additional investments in 2023 at the same levels of headcount increases as we saw in the last 2 years to drive for those numbers. And there will be a very significant natural benefit from the ending of the cloud delivery harmonization program. Just to give you a view here, in Q2, we had more than €100 million in investments tied up in the cloud delivery harmonization program. We expect similar amounts in the second half year once this has tapered off, of course, that is already a very big help. So I would say if we continue to assume a difficult but not a doomsday macro environment for 2023, we're extremely confident that we will drive for the double-digit growth.
And Adam, maybe also just let me summarize it from a strategy perspective. When we look back, I mean, we started this transformation 2.5 years ago. And Scott, I guess it's fair to say that last year, it took a bit of time until really RISE took off. And we had good software quarters, a bit better than expected. Now this year also because of the macroeconomics, we're actually a bit below plan. But what we see is now on the cloud, we have a super resilient business. I mean once you're going into this project and you're moving the ERP to the cloud, you are transforming, you are not going away. The new way is a super high and also the backlog now we build up with the platform, Nestlé just celebrated a big go live. Now we are co-innovating on the platform, building new apps, surrounding the core. So we see new businesses also for the customers we already closed.
If you would have asked me 2 years ago, will all line of businesses grow double digit? Not all were in the shape and form of today. Also that one, super resilient now good growth, gaining market share back in procurement, SuccessFactor, the core is developing really well. And now with the a little bit weaker software license business, I mean, for 2023, that gives us a higher recurring revenue share. That gives us even more confidence that we're going to make the double-digit operating profit growth because we actually clearly on plan. If you take out Russia on the profit side, we have a more resilient, more recurring revenue base and the cloud actually performs well ahead of plan, I would say.
And perhaps just a last comment. You see that resilience also in our support revenues, which are essentially flat now for a long period of time despite the pronounced software license declines. So also there, the stickiness is extremely high. And we have actually, again, had very, very nice multipliers in terms of support to cloud conversions, actually this quarter around the 3x mark, which is quite remarkable. And I don't see this going away or changing any time in the foreseeable future either.
Thank you. We will take the next question please.
Next question from Johannes Schaller from Deutsche Bank.
Thanks for taking my questions. And Christian, we're very clear on the strong pipeline on the cloud side. But then if we look at Qualtrics and also some other software peers, a bit of commentary that deal cycles are maybe lengthening and things tougher to get decisions done really. So I just wanted to check with you, I mean, is Qualtrics really the exception here in your portfolio? And are you pretty confident that your cycles are not lengthening in the rest of the cloud portfolio from what you see right now?
And then second question just for Luka. Given the cloud investments are not really going to expand further into the second half, how should we think about the cloud gross margin trajectory? I mean can we stay around that 72% level into the second half? Or how should we think about that?
Yes. Let me start with the Qualtrics question and the overall sentiment. I mean with Qualtrics, the last 2 years, we built more and more integrated X+O packages, how we call it, where we can embed Qualtrics in the business processes of our core applications. And you have seen how they have accelerated their growth. They are still on a high growth. And in the second half of the year, further packages will come, the integration on the product side. We will launch a few more scenarios around RISE for the IT, where you can track and trace how is the sentiment with regard to the transformation. We're going to build in Qualtrics into our procurement portfolio, so high-growth areas where we see a lot of opportunities to attach Qualtrics. So actually, I'm very confident.
The deal cycles, when I look at RISE and S/4HANA, and let's start with the flagship product. The conversations are now going more around, “I have certain parts of my businesses where I see huge optimization potential. Yes. So can we go on procurement faster? What can we do on billing automation? I want to launch new OpEx-related license models. Christian, can we move into that angle?” Okay, fair. We are very flexible commercial RISE and wise, let's go into these areas first. A delay, maybe a shift of priorities, yes, but not a delay. And again, it's very important we are not only doing here a shift to the cloud. We're only with a shift to the cloud, I would say maybe the business case would not look as strong in such a macroeconomic time. But with everything around with the resilience, which comes with our products, this is not a discussion yet to stop any kind of deal cycles or actually delaying projects. And so this is where I'm also gaining a lot of confidence just to talking to my peers. Scott?
Yes. Look, just to give it a bit more color to what you described, Christian. The first is, we are not just moving workloads. We're enhancing capabilities. And when they choose SAP, they're choosing an enhanced capability. They need a business that can manage inventory levels at different than what they did before. They go from just in time to just in case. They're moving the ability to be able to manage multiple suppliers in real time because of disruptions to their supply chain. That's an enhanced capability. So what we are seeing in the deal cycles at volume is a sharper prioritization about the transformation plan, which is exceptionally good because it means we're very clear what outcomes need to be delivered in the cloud by when. But it is not about a delay of deal cycles, it's more about sharper transformation plans, which, of course, RISE with SAP brings as a part of the service. So that would be an overall statement.
And then obviously, then, between all of the different categories, which are all growing at that double-digit growth, each of them will have a sharper business priority because businesses need to be clear about the outcomes that they're getting. That gives us confidence because even in good times, SAP is strong, but in difficult times, we're even stronger.
Yes. And just to add on that and to answer the question on the cloud margin. So first of all, I'm very pleased with the progress that we have made in 2022 despite the headwinds from the increasing investments in the cloud delivery harmonization program. The 2.3% cloud margin increase was actually a bit more than I would have expected. So we are now ahead of plan. And when I take a look at the second half year, the investments will further slightly increase in the second half year. But on the same side, I mean, the cloud revenue growth is also very strong. So while I have at the beginning of the year said that we will look at a flattish cloud margin development for 2022, I think it's now likely that we will end up with a slight increase in the cloud margin already in 2022. And then obviously, with the investments tapering off in the first half year, actually, our cloud exit margin end of 2023 should be significantly higher than the 72% that you are highlighting or that you have been asking about.
The more important topic is that our absolute cloud profit is actually getting more and more ahead of our original planning because of the success in our cloud momentum and the great success of S/4HANA in particular, and I think that's the bigger story to watch out for and one that we are certainly ahead in terms of where we thought we would be from a midterm ambition perspective as well.
Thank you. Next question please.
Our next question from Mohammed Moawalla from Goldman Sachs.
Great. Thank you very much. I have 2 questions, please. The first one, maybe for both Christian and Scott. As we look at SAP's sort of cloud portfolio, it's pretty broad and I would be curious to understand the more kind of defensive lower ASP aspect of the mix of the portfolio versus perhaps more discretionary aspect. I know S/4HANA momentum is pretty strong right now. But if we were to move to a more cautious or even more severe macroeconomic scenario next year, how do you sort of assess the risks of the different sort of pieces of the discretionary versus the more defensive aspects of the portfolio going forward and impacting kind of backlog growth and revenue growth in the cloud?
And then the second one was for Luka. You talked about kind of the heavy investment this year. But as we think about Cost Flex, in the past, SAP has shown the significant ability to reflect cost to protect margin. So in the context of your sort of expected double-digit EBIT growth next year, how do you sort of see the scope to kind of flex the cost base to kind of hit that target even in the absence of, say, with growth slowing?
So maybe I'll start, Christian, and then you add comments. So on the first question around the portfolio and what's discretionary, it's interesting businesses. Have different views about what's discretionary and what's not, but I'll try to give it at a macro level. First of all, this is one of the advantages of SAP and our breadth of our portfolio. We're one of the only organizations, I would argue, the only company that is able to provide solutions that are able to enhance the customers, whether it's solving employee challenges and retention of their workforce, whether it be solving their supply chain disruptions, whether it be about managing their green line, sustainability, managing their contingent labor. So our breadth really helps us because each business will be faced with specific challenges, but through the relationship they can expand.
Having said that, what we are seeing is the macroeconomic situation. Christian speaks a lot about the ability to be able to manage your supply chain disruptions, your ability to be able to source and manage our supplier base in a very diverse and realtime environment. They are consistent and strong. And so the core part of the portfolio, we see really strong demand and pipeline going forward, And I don't expect that to change because even in a difficult environment, those needs become more apparent than ever.
But then within the other parts of the portfolio, for example, some businesses are much more focused on the core HR operations, which SuccessFactors provides. But they might not look at discrete solutions that they would consider to be discretionary. So they focus a lot more on the core capabilities there if they've got decisions to be made about finite operational OpEx spend.
What I would say is clear. In past macroeconomic, difficult environments or uncertainty, there was always pressure on IT spend. I do not expect that to be the same as in go forward. Technology spend continues to be a priority for companies as they need to be able to resist and manage the disruption and take advantage of opportunity. And that's why our pipeline continues to look strong across the portfolio and gives us confidence in the outlook. Christian?
And I mean when you look into a business case justifying to do RISE with SAP, obviously, there's always a point on how can we outsource certain parts of IT? How can we outsource the one side of the house? Cybersecurity is a big topic. Let's not forget that, they're increasing concerns, which also makes the move to the cloud more needed.
But then second, as Scott just said, I mean, I give you a realtime example. Yesterday, with Samsung and other players in the semiconductor industry, we are now moving them with RISE with SAP, not only to the cloud, but we're actually building a very resilient supply chain. We are moving them to the network where they find millions of suppliers and buyers also for their industry and then we are building a resilient supply chain. And these are the scenarios which especially in these times are so crucial. So it's about the move to the cloud, but even more automation to offset some of the margin pressure and supply chain challenges our customers are facing.
Just finally on the Cost Flex scope that you have discussed. I mean as we have proven on past occasions that you rightfully point out, if we really had a severe downturn situation to manage, we have certainly scope for easily finding a mid- to high triple-digit million euro in savings across different expense line items in terms of reduced headcount growth and third-party expenses and other discretionary expense items on top of what we anyway will see with the dissolution of the cloud delivery harmonization program. So we have, of course, significant scope to manage the bottom line in line with our commitment.
Thank you. Next question please.
The next question from Michael Briest from UBS.
Yes. Christian, could you just say what you're waiting to see in the marketplace or your own sort of trends in order to revisit the midterm guidance? And then obviously, you're suggesting the cloud transition faster. So you're substituting the 87% gross margin on-premise business with probably sort of [72%] cloud business. I know Luka, at Sapphire, you were adamant that the €11.5 billion EBIT in 2025 was well underpinned even if the mix changed. I am wondering if you're happy to reendorse that today?
Yes. So Michael, what do we actually need to uplift our guidance? First of all, I would value if you guys could value again, a bit more the growth in the cloud. And I mean when I compare this to a year ago, it was all about the growth. Of course, we realize the market sentiment has shifted. And look, we always said it's a 3-year transformation. And mathematically, it was always the case that the first 2 years, a bit more difficult on the operating profit side. But just yesterday, I did the math. If you now take out Russia for a second, we're even ahead of plan on operating profit. So we are well on plan on hitting our midterm ambitions.
Now what do we need to have in order to give a new guidance? I would say, look, let us deliver a great half year 2. Let us show that the cloud is very resilient. And if the macroeconomic environment stays like it is, let's assume that, then you're going to see us beginning of next year updating the guidance, and I want to emphasize that. You will not only see an update in the guidance on the top line. There is, of course, also then an update to be expecting on the bottom line.
Yes. And this will be a positive update all along because as I said it’s not only the growth on the cloud side, that is great from momentum perspective. Of course, it’s also going to -- at the current FX levels materially supported by the currency. But this drives also much higher absolute cloud profit and at the higher growth rates in the cloud, actually that can overcompensate the margin differential in terms of what it contributes from an absolute profit perspective. And therefore, we expect our momentum to also flow through to the bottom line. As we said, let’s watch how the performance goes, what the macro does if it stays at the same level. And also of course continue to prove out performance from a backlog perspective. But then we have all ingredients in place for an update that will please investors of all tastes I would say.
And can I just ask, previously you had a 2023 target and that was replaced in 2020 with a '25 ambition. We're now in -- going to be in '23 in six months' time, would you update '25 or would you introduce a new midterm target beyond that?
No, we would look at updating 2025. And of course, we will give a guidance for 2023 that you can then compare to the -- to the old 2023 guidance. I would say that probably on the cloud side will look quite pleasant.
Thank you. And now we will take one final question please. Thank you
Our final question comes from Mark Moerdler from Bernstein Research.
Thank you very much for taking my question, squeezing it in, and I appreciate the additional detail you've given on the call so far. I have 2 not too complex questions. The first is you've said that roughly 50% of S/4HANA SaaS was new customers and you're winning in smaller customers. Can you give us any color on what percentage of the S/4HANA cloud revenues from new customers versus how much of the customer base is? And the second question is on return of cash, you've added €500 million to available to buy back stocks. How should we think about the share count going forward, especially with the valuation of the stock being down where it is?
I can start on the net new, and then Scott, you can build on that. So first our net new customer share for S/4HANA cloud is 60%, so 6-0. And what kind of customers are those? Oftentimes, I mentioned it in my comments at the beginning, Doctolib the unicorn in France, very successful, high growth, need scalability, also wants to go expand the business now into other segments. This is where we are winning net new. We're also winning net new in larger customers but of course, much less as ERPs very sticky than, of course, in the midsize or in the unicorn community. But again, you see it from the share of net new customers, I guess that also shows you what kind of value the product has to offer if you have such a high share of net new customers.
Yes. Maybe I'll add 2 comments, Christian, if I can. The first, when we launched RISE, we obviously had a high proportion of net new builds at midsized customers when we first launched as we scaled out the service. What we've seen increasingly is not only have we improved or increased the total customers moving to RISE, over 2,000 customers now moving to RISE, 400 in Q2, but also the proportion of larger customers which are in that mix of the revenue of the order entries that you will see on larger customers continues to lift. That gives us, obviously, optimism in terms of our outlook, but also the revenue mix has an increasing proportion of large customers. That's not at the expense of the midsize. The midsized customers continue to expand. Our net new customers tend to be midsize or the unicorns that Christian mentions, but the big companies are now moving at scale to move across as well, which means the revenue mix of large companies is higher.
Yes. And just to come back on the share buyback and the share count question. I think it's important to understand we are buying back the shares just as we did for the first share buyback that we did in the first half year, primarily in order to satisfy the equity-based compensation plans of our employees and counter any dilution for our shareholders. So essentially, we are not canceling those shares. And therefore, the -- you can expect that the aggregate share count will remain unaffected, but we make sure that we don't create additional dilution.
Why have we decided to buy back an additional €500 million in shares? Very evidently, we are committed to continuously refilling our equity pool for the share-based compensation plans. And it is It makes sense to do a bit more on that in 2022, strongly believe that it does not underpin the true value of the company and its strategy. So that's why we decided to accelerate the volumes for 2022.
Outside of that, our capital allocation priorities remain unchanged. We, of course, will continue to invest as is reasonable and necessary in our organic business. So we will continue to deleverage where it makes sense. And obviously, in the current interest rate environment, we will continue to be committed to that. Then we will pay an attractive dividend also in the future. If we have M&A opportunities, then we can pursue them when there are tuck-ins also out of the existing cash flow. And on top of everything else, if we then have no other uses, of course, we might continue to accelerate some share buybacks to fuel the treasury stock for our equity programs for employees at attractive prices. This is not something I would rule out. But again, it will not result in a long-term reduction of our share count as it's really meant to offset dilution.
Thank you. And this concludes our call for today. Thank you.
Thank you, everyone, for joining.
Thank you.
Thank you. That concludes today's conference.