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Oracle Corporation (NYSE:ORCL)

F2Q09 Earnings Call

December 18, 2008 5:00 pm ET

Executives

Larry Ellison – CEO

Jeff Epstein – EVP & CFO

Safra Catz – President

Charles Phillips – President

Roy Lobo - IR

Analysts

Adam Holt - Morgan Stanley

Sarah Friar - Goldman Sachs

Heather Bellini - UBS

John DiFucci - JPMorgan

Peter Goldmacher - Cowen & Company

Brent Thill - Citigroup

Brendan Barnicle – Pacific Crest Securities

Operator

Good day everyone and welcome to today's Oracle Corporation second quarter fiscal 2009 earnings conference call. Today's conference is being recorded. At this time, I would like to introduce Roy Lobo, Head of Investor Relations at Oracle; please go ahead sir.

Roy Lobo

Good afternoon everyone and welcome to Oracle's second quarter fiscal year 2009 earnings conference call. With me on the call are Oracle’s Chief Executive Officer, Larry Ellison; Oracle’s President, Safra Catz; Oracle's President, Charles Phillips; and Oracle’s Executive Vice President and Chief Financial Officer, Jeff Epstein. We will begin with a few prepared remarks and then take your questions.

Let me begin by reminding everyone that today's discussions may include predictions, estimates, or other information that might be considered forward-looking. While these forward-looking statements represent our current judgment on what the future holds, they are subject to risks and uncertainties that could cause actual results to differ materially.

You are cautioned not to place undue reliance on these forward-looking statements which reflect our opinion only as of the date of this presentation.

Please keep in mind that we are not obligating ourselves to revise or publicly release the results of any revision of these forward-looking statements in light of new information or future events.

Throughout today's discussion we will attempt to present some important factors relating to our business that may affect our predictions. You should also review our most recent Form 10-K and Form 10-Q for a complete discussion of these factors and other risks that may affect our future results or the market price of our stock.

A PDF copy of our press release and financial tables, which include a GAAP to non-GAAP reconciliation, can be viewed and downloaded on the Oracle Investor Relations website at www.oracle.com/investor.

With that I would like to turn the call over to Jeff Epstein for his opening comments.

Jeff Epstein

Thank you Roy, good afternoon everyone and thank you for joining us. I’ll review our non-GAAP financial results focusing on constant currency growth rates unless otherwise stated.

During the quarter the Euro, the British pound, and many other currencies fell substantially compared to the US dollar. This currency impact reduced new license revenues by 8%, total revenues by 7%, and earnings per share by 9% or $0.03 per share.

In the second quarter our new software license revenues were $1.6 billion, up 5% in constant currency and down 3% in US dollars. EMEA grew 7%, the Americas grew 3%, and Asia grew 5%.

Technology new license revenues were $1.2 billion, up 12% in constant currency and up 4% in US dollars. EMEA grew 16%, Americas grew 10%, and Asia grew 8%.

BEA contributed approximately $127 million in new license revenues this quarter. Applications new license revenues were $469 million, down 9% in constant currency and down 15% in US dollars. EMEA was down 16%, Americas were down 6%, and Asia was down 2%.

Our software license updates and product support revenues were $2.9 billion, up 21% in constant currency and up 15% in US dollars. Renewal rates continue to be very high because customers value the benefits they receive from our updates and support fueled by our $3 billion annual investment in research and development.

Our services revenues were $1.1 billion up 5% in constant currency, and down 2% in US dollars. On demand revenues grew 19%, consulting grew 4%, and education fell 3%. Our total revenues were $5.7 billion, up 13% in constant currency and up 6% in US dollars.

Operating income was $2.6 billion, up 25% in constant currency and up 18% in US dollars. Our non-GAAP operating margin grew by 460 basis points in US dollars to 46%, a record level of profitability for Q2.

Our tax rate was 29.0%, higher then our guidance of 27% due largely to the foreign exchange impact on our earnings mix. We have a higher tax rate in the United States then abroad so a strengthening dollar will tend to increase our overall tax rate.

We increased our stock repurchase activities in the quarter buying 108 million shares at an average price of $17.14 for a total of $1.8 billion for the quarter. As we have previously stated the rate of our buyback will fluctuate each quarter taking into account our stock price and alternative uses for our cash.

Our non-GAAP earnings per share were $0.34, up 18% in constant currency and up 9% in US dollars. Our non-GAAP EPS was negatively impacted by $0.03 per share due to the strengthening dollar.

Turning to the balance sheet we have $10.6 billion in cash and investments after our $1.8 billion stock buyback. Our day sales outstanding improved from 55 days last year to 52 days this year as we continued to focus on the quality of our receivables and the effectiveness of our collection efforts.

We believe our bad debt reserve is appropriate and our reserve policy remains consistent with prior periods. Overall we generated a record $7.6 billion in free cash flow over the last four quarters growing 15% over the prior year.

Now let me turn to guidance for the third quarter, like last quarter we will give guidance both in constant currency and in US dollars. Using today’s exchange rates implies approximately eight points of negative currency impact on our Q3 growth rates.

For the third quarter we expect new software license revenues to grow a negative 2% to plus 8% in constant currency and minus 10% to flat assuming today’s rates.

We expect non-GAAP and GAAP total revenues to grow 8% to 11% in constant currency and 1% to 4% assuming today’s rates. Assuming a Q3 tax rate of 28.5% we expect non-GAAP earnings per share to be $0.34 to $0.36 in constant currency and $0.31 to $0.33 assuming today’s rates.

We expect GAAP earnings per share to be $0.26 to $0.27 in constant currency and $0.22 to $0.24 assuming today’s rates.

We’d like to highlight three observations, first we have a large revenue and customer base diversified by product, by geography, and by industry in both the public and private sectors. We believe this broad platform allows us to outperform our competitors.

Second our software license update and product support revenues on a trailing 12-month basis were $11.5 billion or approximately 48% of our total revenues with very high renewal rates. During the technology downturn from 2001 to 2003, our support revenues grew by 10%.

Third we believe in continued investment in research and development. At the same time we are sensible in our approach to controlling costs. As a reminder during the last downturn our operating margins grew by 180 basis points from 2001 to 2003.

Now I’ll turn the call over to Safra.

Safra Catz

Thanks Jeff, as Jeff mentioned and all of you know the dollar strengthened substantially during the course of Q2 and the impact of the move in the currency also depends very much on the timing of the move in the quarter.

As you know the dollar was under 1, 130 against the Euro for the entire month of November and for us that’s both the last and the most important month of Q2. As Jeff indicated we hit our license growth target on a constant currency basis and in dollars, currency impacted our new license revenue growth by five points more then the three points assumed in our September guidance.

This brought us to a total of an eight point year-over-year headwind effectively bringing our Q2 new software license revenue guidance from the 2% to 12% to negative 3% to 7% based on currency alone. What’s not so obvious is the impact of currency on all the other line items.

Such a substantial swing in currency during the quarter impacts us across the board including for example the nearly two points on our tax rate which by the way accounted for another cent of EPS. The strengthening dollar effects our revenue mix subjecting more of our revenue to the US tax rate which is of course among the highest in the world.

To give you a tangible example of the currency impact on tax the shift in the dollar alone during the quarter completely overwhelmed the benefit we received from the R&D tax credit. Even ignoring the tax rate impact I just spoke of, had the dollar not strengthened so substantially throughout the quarter our non-GAAP EPS would have come in at around $0.37, again $0.03 higher, then what we reported today.

Now of course obviously currency was not the only news going on in the quarter in the outside world and yet we feel just extremely good about our results. We’ll continue to make the smart choices as we manage the business but as Larry and Charles will address, the product and competitive positioning of the company is strong and that shows in the results.

When you combine our product strength with our financial strength already delivering the highest margins among our peers and nearly twice as high as SAP, we believe we are well positioned relative to all of our competitors.

With that I’ll turn it over to Larry.

Larry Ellison

Thanks Safra, I’m going to highlight three separate product areas; middleware, sales automation on demand and our new database machine.

Middleware sales continue to grow very strongly even in this economic climate, even after correcting for the strengthening of the dollar. We believe we are at least the same size as IBM in middleware and we may have in fact, have passed them to be the number one middleware company.

If we haven’t passed them, we are very, very close in terms of revenue and our middleware business is growing dramatically faster then IBM’s middleware revenue.

In sales on demand, our primary competitor there is salesforce.com and this quarter was conspicuous and a series of competitive wins against salesforce.com. One which was our largest ever on demand or cloud computing, whatever you want to call it, a competitive win over salesforce.com was actually a replacement of salesforce.com.

The customer will be de-installing salesforce and replacing it with Oracle sales on demand so we’re very excited about that. That business is now growing.

When we compete head-to-head with salesforce we win more deals then we lose and that’s new in the last couple of quarters.

And finally the Oracle database machine which we introduced in Open World or we announced in Open World and we’ve begun selling this past quarter. As measured by pipeline growth and pipeline size, this is the most successful introduction of a new product in Oracle’s history so there’s huge interest out there and quantified by an enormous pipeline which we’ve built.

We think its going to be a while before we are able to convert this pipeline, we’ve got a number of demonstration machines both Oracle and Hewlett Packard being put in the hands of customers but that business looks very, very promising and should help us drive growth over the next 18 months.

With that I’ll turn it over to Charles Phillips.

Charles Phillips

Thanks Larry, just to give you a sense of the activity of what’s going on out there our customers continue to engage in discussion, evaluation of new projects and technologies, our community is very active.

Our sales events attendance which is a good indicator of future activity is still growing and up year-over-year as is our pipeline and obviously we have to see how that closes out in the balance of the year.

But our strategy of having an integrated [stack] that spans database, middleware, CRM, ERP, and industry applications plays very well in an environment where customers are having to rationalize technology investments and reduce complexity.

So we can help customers consolidate these systems, retire customizations and below cost platforms better then any other company so those messages aren’t new for us. We’ve been consistent in saying them but they are suddenly much more relevant to customers right now.

A few comments by product area, and database area, to highlight as Larry mentioned was the HP Oracle database machine which is certainly attracting a lot of interest out of the gate. Just to give you a sense of why that is, [Mobile Tel] for instance is evaluating our database machine for fast performance on 65 billion records of data.

Their initial query performance is 10x to 72x faster then their current systems. The Chicago Mercantile Exchange, they had a query that was taking four minutes, they tested it, and it ran in 10 seconds. They weren’t even aware that the query had completed.

So that’s the type of performance that we’re seeing and the machine is starting to sell itself. Moving on to middleware, middleware was clearly the standout in the quarter. We continue to post strong numbers there in market share gains.

I just wanted to clear up a little controversy on kind of how we’re doing post BEA since there have been some questions out there. So number one, all the products within [Fusion] middleware are growing very strongly including [inaudible], portals, BI, identity management, and content management.

We now have 80,000 customers. We are growing at four to five times the rate of IBM Web Sphere. We are clearly taking share so I wanted to give you a sense of the types of head to head wins we are enjoying against IBM Web Sphere and just in Q2 alone, companies like [Rapeon], The IRS, DFW Airport, USDA, New Core Steel, China Mobile, [Dubai] Insurance Group, Toshiba, The Good Guys in Australia, Nebraska State College, South Bank, the German Federal Employment Office, KB Finance Group, [Telephonica], and there’s more we could talk about.

So we’re continuing to enjoy a strong performance in middleware and gaining market share there. Other general wins for middleware on the general platform, Wellington Management, application server PG&E where we replaced Net Weaver, Verizon Communications, [Equinex] where we replaced [JBoss], for the [inaudible] platform the University of Arizona, I EEE, for performance management the Hyperion products, St. Jude Medical, Internal Revenue Service, even though they’re using the SAP backend they want to consolidate in our products.

Business intelligence, we had good wins over business objects and SAP at [We Pro], Fitch Ratings, Network [World] in the UK, content management good wins at Allstate, Department of Labor, and [Accent] Australia. In identity management, International Paper where we replaced Computer Associates and [Megabond].

In the applications area Larry mentioned that we’re doing very well in CRM on demand and we’re certainly getting our traction now. What we think is happening is is the market is becoming more sophisticated as enterprises start to deploy and scale and they’re demanding enterprise integration scalability and security.

We have strong customer adoption at Siemens, we had a 12,000-seat win, that’s [inaudible] implementation and we’ll become the standard there. US Food Service where we beat salesforce.com about 7,000 users there. [Matreol] Healthcare displaced salesforce.com there and in West Pack where we also beat saleforce.com.

So we have had quite a bit of momentum there and I forgot to mention [Swisscom] as well, another 3,000 seats. We’re making good progress on AIA, our integration platform. Four new process integration packs in the quarter, that makes a total of 20. We shipped JD Edwards to [inaudible], Siebel trade management, to [demantra] and to several others.

Some addition application wins to highlight, ERP, [Gentrix] Corporation, [inaudible]. In the area of CRM on premise, HP and Eli Lily. For Agile PLM, [Telmar] Networks, Digital Health Group, Demantia, Demand Planning, NCR Corporation, Land-o-Lakes, transportation management, McGraw Hill and [Valspar].

In the area of banking, Brazilian American Merchant Bank and Union Bank of California. Our communications GBU had another good quarter, won Cox Communications which was a replacement win over [Amdocs], Swisscom, Tacona Digital Networks, another win over Amdocs, and [inaudible] UK.

In tax and utilities CBU, good wins at the Mexican [Tax] Institute, Trust [inaudible] and in healthcare, [Sharingplow] and Elon Pharmaceuticals. This is also a good time for people to consider focusing on ways on getting to the latest release and we’re seeing a lot of good activity there. Once they’re on the latest release is they become eligible for more add-on and product sales for us for up sell and cross sell.

So just to give you a sense of that Siebel 8.0, 42% of the customers on the latest, people soft 9.0, 40% as well. And we’re seeing more customers move about 4% to 5% a quarter for each of the major product lines. We had about 25 new releases this quarter for our major applications. All those major product lines are certified on 11G. That helps our uptick there as well.

And then lastly some go-lives in the quarter that are important to track, Face Book and HBO, on the enterprise EBS R12 Green Mountain Coffee, Duke University. In addition we had Payless Shoes, Pfizer Animal Health, Monster Worldwide, [Synaptics], and Las Vegas Water Supply.

With that, we’re ready for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Adam Holt - Morgan Stanley

Adam Holt - Morgan Stanley

On the maintenance revenue it sounds like there was a currency impact on the quarter on a year-on-year basis obviously can you talk about the currency impact sequentially and maybe drill down on your comment about renewal rates being consistent, was there any change on the pricing side or any other mechanics around the maintenance stream.

Jeff Epstein

The renewal rates were consistent and in non-GAAP constant currency year-on-year license updates and support was up 21%. I think that’s the right way to look at it.

Larry Ellison

There’s a little bit of seasonality in support but, so year-on-year it’s the appropriate metric.

Adam Holt - Morgan Stanley

And on the technology business it sounds like middleware was an area of strength, you still grew on a constant currency basis despite how tough the market was can you talk a bit about the other areas, the core database, and maybe some of the options, what you saw from a segment perspective.

Larry Ellison

In the core database business we were—

Charles Phillips

Work it down on a combined basis, of course we don’t break out the numbers between middleware and database. What I’d say to that, obviously the options continue to do very well. With the database machine out there obviously we have a strong pipeline building there. All the components of middleware we’re doing well also.

So I think we’ve been fairly consistent with recent quarters.

Jeff Epstein

Twelve percent in currency and database and middleware all together compared to 22% last year.

Operator

Your next question comes from the line of Sarah Friar - Goldman Sachs

Sarah Friar - Goldman Sachs

On maintenance again, because clearly that’s what we love about the Oracle model is the maintenance line, but as customers came back through the quarter did you find that they were trying to negotiate down maintenance, maybe taking a lower service level, just broadly how resilient do you think that line can be as we go into the teeth of this recession.

Larry Ellison

We only offer one service level for maintenance. We offer, seven days a week, 24 hours a day enterprise level maintenance so there’s, we offer a full service system and we don’t have different levels, we don’t have a gold, silver, platinum kind of maintenance.

In addition to that we offer advance customer services which people can buy on an hourly or a daily basis. A few customers tried to negotiate but that’s nothing new. We experience that all the time and our renewal rates were consistent with previous quarters and I’d say nothing out of the ordinary happened.

Safra Catz

As you know usually this maintenance on software is an extremely small percentage of many of our customers’ IT budgets. The bulk of their budget is actually labor, both their own and systems integrator and things like that so their maintenance bill is added up for use for all sorts of different companies software now as we’ve acquired more and more companies.

But the renewal rates remain very, very high because the software is usually absolutely critical for them to continue operating.

Sarah Friar - Goldman Sachs

On the application business, clearly it’s a tougher area then maintenance as we’re in a recession, are you changing anything with regard to go-to-market, maybe thinking more about smaller tactical deals just to keep momentum on the application side.

Larry Ellison

I think customers are signing up for fewer multi year $100 million contracts and implementation but fortunately we have a very broad portfolio. We continue to add to it with Prima Vera, things like [Damantra], the number of things we purchase, allow them to implement very specific best of breed applications and get a very rapid return on investment where its not a multi year project or an incredibly project before they get a benefit.

So we’re seeing more of those projects then let’s say a huge multi year ERP system coming in. Though we get those also. We’re winning deals in the government. We just recently won another state with a very large ERP implementation.

Operator

Your next question comes from the line of Heather Bellini - UBS

Heather Bellini - UBS

I had a question in regards to your close rate assumptions for license revenue, I’m just wondering how you go about handicapping the close rate assumptions given how challenging the current environment is and then I had a follow-up question on operating margin, these are margin levels that are usually reserved for your fiscal Q4 and I just was wondering if you could share with us what type of efficiencies, what drove the efficiencies this quarter to get the margins that high and how should we think about your ability to continue to get the efficiencies out of the business.

Safra Catz

The issue with margins for us is really much less about cost as it is about the mix of our business and as we’ve told you all for really a number of years the large subscriber base we have, the large number of existing customers that are already using our software who pay for update rights, so they don’t have to re-buy the licenses is a very profitable part of our business and as that number gets bigger and bigger it is really impossible for us to actually spend our way through it.

And so in general that is sort of the overriding thing that guides our margins consistently higher. There are, at any particular quarter there’ll be anomalies here or there based on a number of different things but that’s really in general the most important thing and that’s why really for a number of years we’ve been explaining to you that our margins are going to continue to go up as long as we manage the business smartly.

The first question you asked actually was about close rates and what we did this quarter as we do every quarter is we have to make some sort of close rate assumptions based on the size of the pipeline. Now our pipelines are and remain very large and continue to grow but we are taking into account the environment. We as I always say read the same newspaper, watch the same shows, financial shows you all do, so we’ve decided that we would take a lower close rate for our Q3 guidance then we have ever had before during the Q3 just because we want to be thoughtful about what Q3 holds for us.

So we have gone ahead and used a lower close rate then Q3 usually comes in at for our current license guidance.

Operator

Your next question comes from the line of John DiFucci - JPMorgan

John DiFucci - JPMorgan

On the guidance, one of the areas you actually got a lot of efficiency here was on the cost of services, so you have services margins greater then you normally have and just even just looking forward how should we model that going forward.

Safra Catz

First of all I just want to remind you as much as I’ve told you about currency on the revenue side, there is impact of currency on the expense side too. Now of course because our margins are so high the benefit of it is obviously smaller. So just understand that currency impacts all those lines also so it’ll make things look slightly different. The fact is that there is a lot of leverage in some of these different services lines and so as you get bigger you can have some expanding margins.

A number of our businesses were operated more efficiently in the services line this past quarter and that’s not really where the big win is. The big win is as license update rights, expenses don’t grow nearly as much as license and products support revenue and growth and that’s where the big leverage is.

John DiFucci - JPMorgan

On the maintenance line, you show nice growth year-over-year 14% and it was actually a sequential decline of 3% and that’s why people are wondering about the sequential impact as far as foreign exchange because typically you don’t see that in this quarter. So if you could just address that.

Jeff Epstein

It is mostly foreign exchange.

Operator

Your next question comes from the line of Peter Goldmacher - Cowen & Company

Peter Goldmacher - Cowen & Company

When you do your win loss analysis following this quarter what were the most consistent themes in why you were winning deals and particularly why you were winning competitive deals and if there was a deal you happen to lose, why you might have lost that deal or deals.

Charles Phillips

We’re in a lot of product areas but I would say that one new theme that we see all the time was consolidating system and rationalizing environments, those old messages are working very well for us and this is a good environment to standardize on a single stack so our strategy plays well to people who are looking to lower costs right now and thinking about it a bit differently. In middleware its just sheer product performance. We have so many feature advantages there and just the comprehensive products we, if we can get someone technically to look at the product line we always win. If we lose its based on some legacy relationship that IBM had but that’s happening less and less.

I feel very good about where we are in middleware.

Peter Goldmacher - Cowen & Company

And when you compete in the applications business and you present an ROI for an all Oracle solution is there a standard ratio of what a all Oracle solution can be relative to say and SAP IBM or even potentially an SAP Oracle solution would be.

Charles Phillips

Well its not just cost, we are less expensive just because we use simpler technology plus the fact that we have features and processes that they simply don’t have, they don’t have a core [inaudible] application, they don’t have a retail merchandising application so some of these areas its us versus building it yourself or buying it from a very small company and so we use those areas as differentiators. You can have that same functionality and domain expertise but based, from a large company on a standard platform.

So if we can get people to actually look at the actual software and do demos, that’s when we win.

Peter Goldmacher - Cowen & Company

You had mentioned that you had ratcheted down your close rate assumption given your time in front of CNBC, are you comfortable sharing any sort of metrics about how much you’re ratcheting down close rate expectations.

Safra Catz

Its really significantly lower both in the average then any previous year. Its quite significant frankly though it may end up being overly low but you don’t know.

Operator

Your next question comes from the line of Brent Thill - Citigroup

Brent Thill - Citigroup

On R&D you had a pretty strong sequential drop, I was wondering if you could comment, you typically haven’t seen that in past years Q1 and Q2, how much more room is there in R&D line, was this just a shift of the expense or was it an absolute stop of some of the expense.

Safra Catz

It’s a bunch of different things. As I said, some of it is related to currency. Some of it has to do with just a bunch of different things. It is not as a result of a headcount decline. It just so happens its between mix and comp payments and I don’t know how much you know about our R&D team, but we have a very large number of folks outside of the United States, in India and currency had a significant impact between US and the Indian Rupees and there’s a bunch of different things related to compensation etc.

Brent Thill - Citigroup

And Larry mentioned at the Analyst Day the pace of acquisitions would pick up in a tougher environment, I guess if you could just characterize, are you thinking about doing a blend of smaller transactions, or are you still keeping in mind some larger transactions as the environment gets tougher into 2009.

Safra Catz

We’re very opportunistic, we’re always shopping and we’re always looking for things that make sense for us but we are continuing to follow sort of our regular rules of return requirements etc. and strategic fit so we continue to be on the same path we’ve been on and we look at things whether small or large all the time.

Larry Ellison

I think that’s exactly right. Some companies have much more attractive valuations right now but I’m not sure they’d be wildly enthusiastic about selling for cash at this point in time. So we’re going to wait and see how things play out and we’re looking at a number of small acquisitions in the vertical areas and some potential opportunities for a large company acquisition if the price is right.

Operator

Your final question comes from the line of Brendan Barnicle – Pacific Crest Securities

Brendan Barnicle – Pacific Crest Securities

On Europe we saw another second unusually weak quarter out of Europe on the app side relative to the other categories and other geographies, any plans to make changes or anything to address that weakness there.

Safra Catz

No actually this is really no different, first of all it wasn’t just in Europe, both Q1 and Q2 are absolutely impossible comparisons on the app side, year-over-year comparisons, and that’s exactly what you’re saying. We actually virtually telegraphed it during the Q1 call for you all.

Last year those quarters, both Q1 and Q2 were up over 50%, up 77% in Q1 and 72% as reported and even in constant dollars you see its in the high 50s and that just ends up a number in the base and so its really a matter of a comparison. It was exactly the same issue if you look at the table we distribute with the earnings announcement, you’ll see that that is exactly what played out in Q1 also and its impacted not only Europe but its virtually in all the regions.

Roy Lobo

I want to thank everyone for taking the time to join us and participate in today’s call. I’d like to also inform everyone that we will no longer be issuing supplemental tables with the press release. You can access those supplemental tables directly on our website. Thank you again.

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