Oracle Earnings: License Revenue Decline Isn't a Major Concern

As I scanned through articles on Oracle's (ORCL) Aug09 quarter earnings, the consensus seems to be that analysts are disappointed at the decline in overall sales and more importantly the decline in new license sales.

Total Sales and License Sales YOY Change

click to enlarge

Source: Gridstone Research

With a 5% Yoy decline in sales to $5.04B and a ~17% decline in new license revenue to $1.03B in the just concluded Aug09 quarter, there is cause for concern. But I would not link it to the health of tech spending or overall macro environment.

As the chart below shows, the composition of software revenue (excuding. services like consulting etc.) for Oracle is such that it accrues more sales dollars from updates/support rather than new license sales. With major acquisitions like BEA (Apr08) and Hyperion (Feb07) contributing to a larger installed base besides increasing the TAM(total addressable market) for software licenses, the updates revenue stream has been a huge cushion for Oracle. In fact, having a larger TAM to sell updates to on a recurring basis has been a cornerstone of Oracle's acquisition strategy. On that front, Oracle has done well or at least not done badly.

License, Updates And Total Software(Lic.+update) Revenue By Quarter

Source: Gridstone Research

But since no major acquisitions have contributed to this recurring revenue stream in recent quarters(the Sun acquisition is not yet complete), the growth rate has significantly declined.

YOY Change In Updates/Support Revenue

Source: Gridstone Research

The license revenue decline looks bad this quarter because the year-ago quarters had the benefit of the inorganic contribution from BEA.

Quarterly Database/Middleware And Application New License Revenues

Source: Gridstone Research

With no new acquisition and the slowdown in corporate spending coming together this quarter after so many years of acquisition-led growth for Oracle, the license revenue numbers for Oracle look worse than they actually are.

YOY Change In Database/Middleware And Application Revenues

Source: Gridstone Research

But despite the decline in sales, Operating profits have stood up well. This is because of two factors: change in sales mix and the cost-cutting measures undertaken.

YOY Change In Revenue And Operating Profits By Quarter

Source: Gridstone Research

As updates revenue becomes a larger chunk of total revenues, the margins will increase since the updates revenue stream has higher margins at the operating level. SG&A costs for update revenues will be far lesser than new licenses since the sales efforts is focused on existing customers. Oracle has benefited from this in the last 3-4 quarters along with the benefit of cost-cutting measures.

For the first time in the last twelve quarters, headcount has declined on a Yoy basis. Other than SG&A costs, software companies have largely fixed cost structures. So any cost reduction has an immediate impact of margins as is the case here.

Headcount Declines On A Yoy Basis

Source: Gridstone Research

So even if license sales is subdued for the next few quarters, Oracle can look forward to grow its update revenues by focusing on its existing client base itself. With additional cost measures, profits margins will only improve in the short-term.

Disclosure: No positions