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Oracle Corporation (ORCL)

F1Q07 Earnings Conference Call

September 19, 2006 5:00 pm ET

Executives

Krista Bessinger - Vice President, Investor Relations

Safra Catz - President and Chief Financial Officer

Charles Phillips - President

Larry Ellison - Chief Executive Officer

Analysts

Jason Maynard - Credit Suisse

Heather Bellini - UBS

Peter Kuper - Morgan Stanley

Presentation

Operator

Good day, everyone. Thank you very much for holding. Welcome to today’s Oracle Corporation quarterly conference call. Today’s conference is being recorded. At this time, I would like to introduce the Vice President of Investor Relations for Oracle, Krista Bessinger. Please go ahead.

Krista Bessinger

Thank you, Operator. Good afternoon, everyone, and welcome to Oracle’s first quarter fiscal year 2007 earnings conference call. This is Krista Bessinger, Vice President of Investor Relations. With me on this call are Oracle Chief Executive Officer Larry Ellison; Oracle’s President, Charles Phillips; and Oracle President and Chief Financial Officer, Safra Catz.

As usual, our prepared remarks will be followed by Q&A. Due to the complicated logistics today, however, of having Mr. Ellison, Ms. Catz, and Mr. Phillips in three different locations, we are going to need to keep the Q&A portion of today’s call quite limited.

Please note that our next major investor event will be financial analyst day being held next month on October 26 in San Francisco, coincident with Oracle Open World. We look forward to seeing you all there and taking additional questions at that event.

In the meantime, let me cover the Safe Harbor statement.

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 opinions 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 to 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 more 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 will now turn the call over to Safra Catz for her opening comments.

Safra Catz

Thanks, Krista. Good afternoon, everyone, and thanks for joining us.

I am going to focus on our non-GAAP results for Q1, then I will review guidance for Q2 and turn the call over to Larry and Charles.

As you can see, Oracle had another very strong quarter, with outstanding performance across all product lines and geographies. We raised guidance heading into Q1 following a blowout Q4, and still exceeded on every metric.

This is our strongest Q1 licensed growth in more than five years and there is no doubt that we are gaining share across all product lines. As I review today’s results, keep in mind that we consolidated i-flex for the first time this quarter.

New software license revenue, including i-flex, was strong with revenues of $804 million, up 28% year over year, exceeding our guidance range of 18% to 25%. Our strength was very broad-based in terms of deal size and was not dependent on any unusually large deals.

Technology license revenues were outstanding across all major geographies, up 15% year over year. We grew 19% in the Americas, 12% in EMEA, and 12% in APAC. The strength of our technology business was driven by strength in both middleware and database. Database revenue was up 10% year over year. Middleware license revenues were up 56%.

This is the last quarter that we will break apart middleware and database license revenue growth rates.

As for applications, they were exceptionally strong as well, with license revenue of $228 million, up 80% year over year. This is actually the third consecutive quarter in which we have had applications license growth greater than 75%.

Applications license revenue growth was strong around the world -- 69% in the Americas, 83% in EMEA, and 126% in APAC. The majority of our application license revenue growth rate was organic, with license revenue, excluding i-flex, Siebel, and Portal, reaching $186 million, up 47% year over year. Recent acquisitions also contributed to our strong APPS number -- Siebel contributing $31 million and i-flex contributing $8.7 million.

Product updates and support revenue was up 23% on a non-GAAP basis, crossing the $2 billion mark for the first time. The renewal rates of this very large high-margin, recurring revenue stream remained best in class above 95%, as our customers continue to renew their contracts with us.

Oracle continues to grow market share and profitability simultaneously. Q1 income from operations grew 29% to $1.3 billion, resulting in operating margins of 36%, up 1% from a year-ago quarter, despite a 1% reduction from the consolidation of i-flex. We continue to expect margins to improve for the year.

We also grew EPS 24% to $0.18 on a non-GAAP basis, coming in $0.02 above our previous guidance and well above our stated goal of 20% average EPS growth through fiscal year 2009.

In Q1, we bought back 67 million shares at an average price of $14.96, spending $1 billion. We intend to continue buying back approximately $1 billion per quarter through the remainder of the fiscal year.

Operating cash flows for the trailing 12 months increased by $1.1 billion to $4.7 billion, while free cash flow increased 32%.

Now to our guidance. It is as follows:

  • New software license revenues are expected to be up 15% to 20% year over year;
  • Total software revenues are expected to be up 19% to 21% on a non-GAAP basis. Software revenues on a GAAP basis are expected to be up 21% to 23%;
  • Total revenue for Q2 is expected to be up 22% to 24% year over year on a non-GAAP basis, with total revenue on a GAAP basis up 24% to 26%;
  • For net income, non-GAAP, we expect growth of 13% to 17%, with GAAP net income of 10% to 14%;
  • Non-GAAP EPS for the second quarter is expected to be $0.22, as compared to $0.19 last year. GAAP EPS for the second quarter is expected to be $0.17, up from $0.15 last year.

This guidance assumes that the annual effective income tax rate is actually up over a point to 30%, up from last year at 28.9. Now, if current exchange rates hold steady for the entire quarter, that will result in three points of positive currency impact for the Q2 numbers I just gave you, but as you know, currencies are likely to fluctuate. As a result, the currency impact in Q2 could be different from our guidance assumptions.

Our Q2 GAAP guidance currently assumes stock comp expense of about $50 million, and we still expect that the stock comp expense for the full year is somewhere between $0.02 to $0.03, so that’s $0.02 to $0.03 for the full year.

With that, I will turn the call over to Larry for his comments.

Larry Ellison

Thank you. I wonder if Charles can go next, and then I will go last.

Charles Phillips

Okay. I just want to make a few comments on how the quarter started off. I think we had a very good start to a Q1 and it finished up quite strong. I think one of the reasons is we had fewer changes to territories and comp plans this year. I think we have gotten that process, though still more to do, will be even better next year with that reduced disruption, so we are very pleased with how the sales force executed in the quarter.

By product area, our fusion middleware, we have 30,000 customers now, and I remind everyone, it is still the world’s fastest growing middleware suite. You may have heard us talk about our hot pluggable strategy. Let me just summarize that.

Basically, each component in our middleware suite is highly standard but also best of breed. What that is allowing us to do is sell into any standard space environment, even if it is our competitors. We can crack into any account with one or two best of breed products and then, over time, customers tend to expand the number of products they are using from Oracle. Some of the larger deals this quarter in fusion middleware started a year ago with one or two components, and then we kept working it and wedged into the account, as we say, and it turned into a much larger deal, and there is more of that to come.

Also, we have innovated a lot of product line. You have heard us talk about that before, but one measure is that 82% of our customers are on the latest two releases of the product. That is unusual in this industry, and the reason they keep upgrading is because they are getting incremental value each time they upgrade.

We have a lot of third-party distribution that we have built up. That is helping a lot, with 5,000 ISDs, 4,500 BARs and, more recently, the systems integrators are really supporting the product. In fact, we just opened up a joint global innovation centre with Accenture at the Oracle campus. That is staffed by joint people from Oracle and Accenture and with reference architectures.

So several other integrators are scaling up right now as well. EDS has established a mainframe modernization program based on fusion middleware. HP Services is doing the same thing, and there are a number of other smaller ones coming up to speed right now.

Then, just to summarize the innovation over the last 12 months, we have won 150 independent awards for fusion middleware, and we have 275 patents. Some of the major go-lives in the quarter -- Disney, IKON, Dell, Rabobank, Vodafone -- all standardizing on our middleware suite.

I wanted to touch on the database options for a second as well. Though we had healthy options growth, but I think the exciting thing is we have four new ones that are really ramping up this year that we did not have last year.

The first one is content DB and records DB. That basically manages unstructured content, and it comes complete with a policy engine that enables organizations to implement enterprise wide document retention policies, and so this is an area we really never had a product for years, and there’s a lot of data that needs to be managed, especially in this area of compliance.

Database Vault -- it’s the only product in the industry right now that allows IT staffs to separate the rows of people who are able to administer data from people who are able to see the data, and with all the compliance issues out there, that has become important as well.

The third one is Audit Vault. That is a consolidated repository of all database log changes to establish a secure audit trail, and then the fourth one, which I think is going to be really big, is Secure Search. That is a search engine to search across private enterprise data. That one will take a couple quarters to ramp up because we need to ship all the adapters for different types of content, but that is on the way.

So just to reassure you, we have additional database options that are ramping up as we speak that are going to help the balance of the year.

A few comments on applications, a very good applications quarter, as you heard. We have counted head-to-head wins over SAP that we can validate of 88 in the quarter. Some of the wins -- Alltel Corporation, Walt Disney World, Lockheed Martin, Duke Energy, Electrolux, and U.S. Steel, which was a big win for us.

The industry applications are also becoming more important. If you look at all deals signed in the quarter, the industry applications approached about 20% of the deals in the quarter, and with some strategic wins -- in retail, for instance, we have not done much business with Wal-Mart in the last decade. We had a strategic win this quarter as they saw the innovation we brought in retail. With sales, for instance, we lost to SAP a year ago at sales. They made some promises we knew they could not deliver on. The project sale, they now have a new CIO. They are replacing the SAP product with Oracle retail products, so we are getting win-back’s, and there are more of those on the way.

So the retail pipeline is quite large. The attach rate of other Oracle applications and technology products to that pipeline is increasing as we get better about cross-selling across the entire organization.

Also ramping up right now is communications, the Portal acquisition. We are getting some immediate synergies there. They are taking up products that there -- Oracle technology portfolio, for instance, they have their own in-memory database. No need to do that. They can use TimesTen, a product that we market commercially. There are several other areas like that, so it will get more efficient with better product.

Going forward, a couple of areas we will focus on, just wanted to highlight, the applications mid market. We are signing up resellers aggressively by each vertical. The same thing we did on the technology side that helped our database business and our fusion middleware business, we are doing with applications. We have a quick configuration technology called Accelerators that is going to help us to target our product for the mid market.

Overall, between applications and technology, we already have 90,000 small business customers, and we are going to go even stronger into that market with our brand name and some packaging. All we need is some additional distribution and we will have that over the next year.

Lastly, I wanted to mention up-sell campaigns. The major opportunity for us to take advantage of this huge installed base in all these products is ahead of us. We have a broad product line with 235,000 customers. We have made the investment to build all the models and normalize the customer data across all these acquisitions. We have built the analytical models for next likely purchase analysis. Looking at historical purchase patterns, we know what people own, we know what the pre-req’s are for them to buy the next product. All that data, all that analysis has been done, and we produced a solid list of highly qualified opportunities globally, and we will be taking advantage of that in the coming quarter. We are pretty excited about not only how the business is going but all the opportunities that we can see going forward.

Lastly, let me mention Open World, for those of you who intend on coming to that. That is October 22nd through the 26th. Paid registrations are already up over 100%. We will probably have over 40,000 attendees there. It is a big closing event for us, and we are excited about that as well.

With that, let me turn it over to Larry.

Larry Ellison

Thank you, Charles. Let’s see, Charles mentioned several competitive wins against SAP in the quarter. What I am going to talk about is our overall strategy for competing with SAP in the applications business. I am going to focus a bit on the next generation of SOA applications, or service oriented architecture based applications.

There are two key success factors, we believe, for next generation SOA applications. The first is a foundation of standards-based middleware. The second key success factor for SOA applications is industry-specific knowledge and products. In other words, going beyond just SAP ERP.

We think Oracle’s current strategy is helping us overtake SAP and win market share. Let me start with the first key success factors for SOA applications, and that is middleware. Historically, successful application companies have always built their own proprietary middleware and tools. SAP built ABAP proprietary. Oracle built Forms proprietary. PeopleSoft had People Tools, Siebel had Siebel Tools, et cetera. Historically, application companies were more than just application companies. They were applications, middleware and tools companies.

In contrast to this history, we believe that next generation SOA applications, or service oriented architecture applications, will be built upon open standards-based middleware and tools. Now, Oracle has spent a long time in the middleware business. Oracle’s fusion middleware is based on Java and other open standards. J-Developer is Oracle’s standards-based Java development tool. Again, this stands in stark contrast to SAP’s NetWeaver middleware, which is based on ABAP, SAP’s proprietary language. In other words, SAP is sticking with a proprietary approach to middleware while Oracle has adopted a completely standards-based approach from middleware and our next generation of fusion applications.

As the market more deeply embraces service oriented architecture, SAP’s non-standard ABAP approach to middleware is hurting their sales and helping us win share.

Second, next generation SOA applications, or SOA applications, require a complete suite of middleware and tools. In other words, the middleware not only has to be standards-based, we also have to have all of the tools. It has to be complete. It has to include not only a language like Java but also BPEL, business intelligence, identity management, et cetera.

Now, Oracle has had a large, $1 billion mature middleware business for some time. SAP’s NetWeaver product is relatively new and still incomplete. They don’t really the have -- they have partial BPEL. They can integrate with BPEL, but you can’t really orchestrate their applications with BPEL. They have very limited BI. They have virtually no identity management and security management.

It took Oracle two years to enhance our middleware for service oriented architecture fusion applications. We started well ahead of where SAP is now in middleware.

We believe it will take SAP years to build the middleware necessary for their next generation of service oriented architecture applications, and ABAP must still be replaced with a modern standards-based language like Java.

SAP is approximately two years behind Oracle’s scheduling -- with SAP’s announcement of their next generation of applications due to be delivered in 2010, they are a full two years behind Oracle’s announced delivery date for our fusion-based applications in 2008.

Okay. That’s the middleware part of the story.

The second part of the story is industry-specific knowledge and products, going beyond just ERP.

SAP has good industry knowledge and products in some industries, like oil and gas, but they lack industry-specific knowledge and products in most other industries. That’s why they tried to buy Retec for retail and knowledge on retail products.

Oracle’s acquisition strategy has moved us ahead of SAP in several industries -- banking, telecommunications, retail, and so on. Oracle will continue to acquire industry knowledge and products. We believe that SAP must do the same, or SAP will become progressively less competitive in several industries and continue to experience slowing organic growth.

SAP’s CEO, Henning Kagermann, is now publicly talking about a more aggressive, and I quote: “a more aggressive acquisition strategy as a solution to SAP’s slowing organic growth.”

As I pointed out before, SAP has delayed their next release. The next release of their applications is in 2010.

We believe that our application strategy is working. A complete suite of open, standards-based middleware is a foundation for all of our service oriented architecture applications, and acquiring industry-specific applications that go beyond ERP -- Retec for retail, Portal for telecommunications, i-flex for banking, et cetera.

Eventually, again it is our belief that SAP will have to abandon ABAP and go to a standards-based middleware. Eventually, SAP will have to abandon their minimalist approach to acquiring industry-specific knowledge and products. But until they do, we will continue to gain application market share quarter after quarter and year after year.

Okay. I will turn it back over to Krista Bessinger.

Krista Bessinger

Great, thanks, Larry. So I think we have time now for just a couple of questions, so we will go ahead and open it up, Operator, for questions.

Question-and-Answer Session

Operator

(Operator Instructions)

We will go first to Jason Maynard at Credit Suisse.

Jason Maynard - Credit Suisse

Larry, please follow up on a couple of the points you were making regarding competition against SAP. As you look out over the next year or so, do you see the share gains against SAP accelerating? Are you specifically still thinking that you are going to be taking share, perhaps not just only in the core markets but also in terms of the next generation middleware platforms around SOA?

Larry Ellison

Well, I think it’s hard for our share gains to accelerate. I mean, SAP’s growth in their most recent quarter was 8% and our growth in our last two quarters was over 80%, so I cannot imagine that our rate of gain will accelerate, but I think our rate of gain against SAP will stay very, very high. I think it includes gains in ERP, gains in CRN, and gains in industry-specific applications.

Also, Oracle middleware is more prominent in SAP shops than NetWeaver is, so we are already ahead of NetWeaver, not only overall, but we’re ahead of NetWeaver in SAP shops, and we think we will continue to gain share even in SAP shops against their outgrown middleware.

We think in light of that, they are going to have to alter their strategy. They are -- we have leap-frogged them in backing via acquisitions, we have leap-frogged them in retail. We have leap-frogged them in telecommunications. I think we are very, very strong in government and we will continue to target other industries.

I cannot imagine them holding on to their existing strategy in the face of market share losses and what is turning out to be a rather slow organic growth for them.

Jason, did I answer your question, or would you like to add to that?

Jason Maynard - Credit Suisse

I was going to follow-up a little bit. On the middleware side, when you look at the adoption of service oriented architecture, it does feel like we are just at the early stages of this game, so as you look at the middleware business relative to maybe applications space, two years from now, is this a business that you think puts you in a position where your percentage share of maybe just overall wallet within the IT environment is significantly larger today? Maybe look at the share gain from that perspective.

Larry Ellison

Our middleware, as Safra pointed out, our middleware grew at over 50%, much faster than BEA or IBM. We think we are unique in the industry of having a database, middleware and applications that all play in concert, that are all modern and standards-based, and we have been investing in kind of our next-generation technology suite, next-generation database, next-generation middleware, for some time and as our fusion applications come out in 2008, we think that is another chance to get way ahead of SAP, since again, I keep -- I will point out once again -- SAP has said they are going to have no other, no new release of their applications until 2010. Now, they still have to make a 2010 date. That means we are going to be out there in the marketplace for two years with modern, standards-based SOA applications while they are rewriting their -- presumably they are rewriting their applications, so I think it is a tremendous opportunity for us to get way ahead of them in ERP, and again, we will continue to acquire industry-specific applications and industry-specific knowledge with our ongoing acquisition strategy.

So if SAP holds to their current strategy, I cannot see us -- our share gains slowing very much at all, maybe even accelerating.

Operator

We will move on now to a question from Heather Bellini of UBS.

Heather Bellini - UBS

Thank you. I have two questions for you. First, Safra or Charles, I was wondering if you could characterize your pipeline entering the November quarter versus what you have had entering the last few 2Q’s.

Then, on your license revenue guidance for the second quarter of 15% to 20%, can you give us an idea, just for everybody, what type of i-flex assumption you are assuming in that number, please? Thank you.

Safra Catz

Charles, do you want to do the pipeline? I have the pipeline numbers here. Charles and I are not in the same location. We have had very robust pipeline for the past few quarters, as I mentioned in the previous calls, but we are taking a really rather conservative view of those pipelines because we don’t know the closing rate. Those are the two numbers you need -- your pipeline and your closing rates. So they have grown really very largely. They have grown very large. We don’t know what the closing rates will be, since we are still adjusting to having Siebel and now there’s Portal and these, you know, these have all added, as well as just the basic business, the Oracle PeopleSoft piece. The pipelines have increased in order and even more so than in previous quarters, but we don’t know the closing rates, so we have taken a -- I would say a conservative view of the closing rates, just to be sure.

As you can see in this quarter, the closing rates again exceeded what we expected.

Heather Bellini - UBS

So versus past Q2’s, you would say that your pipeline is better entering the quarter, or in line with what you have seen in the past?

Safra Catz

No, our pipelines are much, much higher.

Charles Phillips

I would also add that our coverage ratio is better versus a year ago, and then the other thing is a lot of the big deals that -- you know, we always start every year with some big deals. Not many of those, really none, have really closed in Q1. That was really a deal, a quarter of medium-sized deals. So the big deals are out there. Some of them aren’t in the forecast, and like Safra mentioned, it is hard to forecast when they will close, but there are big deals out there that again, we did not get in Q1 that are still alive.

Heather Bellini - UBS

Okay, and then just a follow-up on the i-flex contribution that’s in the 15% to 20% forecast?

Safra Catz

Well, since i-flex is a public company, we actually do not get their projections from internal projections. We have assumed a little bit over $9 million is i-flex in license revenue. That is pretty much sort of what we are expecting.

For consulting, it is closer to $70 million, because that is sort of their breakdown. Their financial numbers are included in arrears, two months in arrears, so you are actually going to have a preview of their numbers, because their numbers for the quarter that we just consolidated them in were available over a month ago, so you will see that.

Operator

We have time for our last question today. This will be Peter Kuper of Morgan Stanley.

Peter Kuper - Morgan Stanley

Great, thanks very much. Safra, one clarification, if you could, on the middleware database, and then Larry, a question around that. So you are not breaking out license from database and middleware going forward, is that right?

Safra Catz

Yes, well, you know, we actually never broke out the middleware numbers. We just gave you growth rates. We are going to go from now on to database and middleware together as pretty much everyone else in the industry does -- IBM, Microsoft -- give you those numbers to some extent together, and so we will be doing that going forward. But I thought for this quarter, I thought it was important that I give you notice that we are going to that and that I tell you that this year database, for this quarter, database was up 10% and middleware up 56%. Did you have a question for Larry?

Peter Kuper - Morgan Stanley

Yes, around the middleware/SOA construct. Larry, you mentioned that people looking at database first applications, and of course middleware, it sounds like a bundle three opportunity. Do you believe fundamentally that this will be more of a, kind of an ongoing maintenance side contracts free in pricing, or is there still going to be some components therein, given the open standards, et cetera?

Larry Ellison

We have a hot pluggable strategy so that you could theoretically be using BEA Web Logic or IBM Websphere, J2EE container and still use our identity management, or our BPEL.

We do have suites. We do have a middleware suite and application suites, but it is very important that we remain open and if you have a commitment to a component made by another supplier, that we integrate with those components in a graceful way, and still have an opportunity to sell our products on top of Websphere or Web Logic or other competitors in the middleware area.

So we are trying to be best in class, open and hot pluggable with competing components, but we hope over time, if Oracle does a good job in delivering its components, you will prefer to use our completely integrated suite as opposed to trying to mix and match amongst multiple vendors.

Operator

I would like to thank everyone for your participation in the Q&A session in today’s conference call. With that, I would like to turn things back over to our speakers for any additional and closing remarks this afternoon.

Krista Bessinger

Thank you everyone for participating again, and I just want to let you know that a telephone replay will be available for 24 hours. That replay number is 719-457-0280. Passcode is 4356887, and you can also access the webcast replay on the investor relations website. That replay will be available through the close of market on September 26th. Thank you very much for participating in today’s call.

Operator

That will conclude today’s conference call. Again, thank you all very much for joining us. Have a good day.

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