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Oracle (NYSE:ORCL)

F2Q10 Earnings Call

December 17, 2009 5:00 pm ET

Executives

Ken Bond - Investor Relations

Jeffrey E. Epstein - Chief Financial Officer, Executive Vice President

Safra A. Catz - President, Director

Lawrence J. Ellison - Chief Executive Officer, Director

Charles E. Phillips Jr. - President, Director

Analysts

Adam Holt - Morgan Stanley

Sara Friar - Goldman Sachs

John Difucci - J.P. Morgan

Heather Bellini - ISI

Israel Hernandez – Barclays Capital

Brent Thill – UBS

Kash Rangan - Merrill Lynch

Operator

Welcome to today's Oracle Corporation quarterly conference call. Today’s conference is being recorded. At this time, I would like to introduce Ken Bond, Vice President of Investor Relations for Oracle. Please go ahead, sir.

Ken Bond

Thank you. Good afternoon everyone and welcome to Oracle's second quarter fiscal year 2010 earnings conference call. I am Ken Bond, Vice President Investor Relations and with us on the call today are Chief Executive Officer, Larry Ellison; President, Safra Catz; President, Charles Phillips and Chief Financial Officer, Jeff Epstein.

As a reminder, today’s discussion will include forward-looking statements including predictions, expectations, estimates, or other information that might be considered forward-looking. While these forward-looking statements represent our current judgment on what the future holds, these statements are also subject to risks and uncertainties that may cause actual results to differ materially from statements being made today.

Throughout today's discussion we will attempt to present some important factors relating to our business which may potentially effect these forward-looking statements. We would encourage you to review our most recent reports on forms 10-K and 10-Q and any applicable amendments for a complete discussion of these factors and other risks that may affect our future results or our market price of our stock. As a result we caution you against placing undue reliance on these forward-looking statements which reflect our opinion only as of today and as a reminder, we are not obligating ourselves to revise or publicly release the results of any revisions of these forward-looking statements in light of new information or future events.

A copy of the press release and financial tables, which includes a GAAP to non-GAAP reconciliation and other supplemental financial information, can be viewed and downloaded from our website at www.oracle.com/investor.

We will begin with a few prepared remarks before taking questions from the audience. In today’s conference call we will only be discussing Oracle’s Q2 of fiscal year 2010 results. With that I would like to turn the call over to Jeff Epstein for his opening remarks. Jeff?

Jeffrey Epstein

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

First, a note about foreign exchange rate movements. In September we told you that using then current exchange rates would increase our Q2 revenue growth by four points compared to constant currency. During the second quarter the US dollar weakened compared to last Q2, increasing our international revenues, expenses and profits when measured in US dollars. As a result, currency movements increased new license revenues by 7%; total revenues by 5%; net income by 7% and earnings per share by 7% or $0.02 per share compared to Q2 of last year.

Now let’s review the income statement. In the second quarter our new software license revenues were $1.7 billion, down 5% in constant currency and up 2% in US dollars. The Americas grew 1%. EMEA was down 11% and Asia declined 8%. Technology new license revenues were $1.2 billion, down 5% in constant currency and up 1% in US dollars. The Americas grew 2%. EMEA was down 10% and Asia declined 10%.

Applications new license revenues were $478 million, down 3% from last year on a constant currency basis and up 2% in US dollars. The Americas grew 1%. EMEA was down 14% and Asia was up 2%. Our software license updates and product support revenues were $3.3 billion, up 7% in constant currency and up 11% in US dollars. These revenues are annual fees that customers pay to receive updated versions of enhancements to their existing products.

Our services revenues were $958 million, down 19% in constant currency and down 15% in US dollars. Our total revenues were $5.9 billion, down 2% in constant currency and up 3% in US dollars.

Operating income was $2.9 billion, up 3% in constant currency and up 9% in US dollars. Our non-GAAP operating margin grew by 280 basis points to 49% in US dollars. This is the highest Q2 operating margin in Oracle’s history as a public company and further demonstrates the success of our operating model. Our tax rate for Q2 was 27.4%. Our Q2 non-GAAP earnings per share were $0.39, $0.03 above the high end of our EPS guidance range of $0.35 to $0.36. This was up 8% in constant currency and up 15% in US dollars. Our non-GAAP earnings per share would have been $0.02 lower had foreign exchange rates remained the same as they were in Q2 of last year.

In Q2 we repurchased 11.6 million shares at an average price of $21.65 per share for a total of $253 million. As we have previously discussed, the rate of our stock buyback will fluctuate each quarter taking into account alternative uses for our cash and our stock price.

Turning to the balance sheet we have $20.8 billion in cash and investments including funds put aside to complete the Sun transaction once all necessary approvals have been obtained. Our day sales outstanding improved again this quarter from 52 days last year to 47 days this year, a testament to the quality of our receivables, the quality of our customers and the effectiveness of our collection efforts.

We generated $8.4 billion in free cash flow during the last four quarters, growing 11% over the same period last year. This is the highest Q2 free cash flow results in Oracle’s history. Now I will turn the call over to Safra.

Safra Catz

Thanks Jeff. As you can see we had another excellent quarter and we delivered these results against a big Q2 last year. We exceeded the high point of our new license guidance, beat the high end of our total revenue guidance, beat the high end of our EPS guidance by a full $0.03 and of course we delivered the highest Q2 operating margin in our history, substantially higher than all our peers.

The strength in the quarter was very broad based, across all product lines and as usual the quarter was not dependent upon any unusually large deals. Once again we grew faster than SAP in every region around the world, clearly taking market share as they have essentially come apart at the seams. Our applications business is growing while theirs continues to shrink at a double digit pace.

Let me turn for a moment to our acquisition of Sun Microsystems. I know most of today’s call is about Oracle stand-alone I will make just a couple of comments about Sun. As you heard earlier this week we expect a full and unconditional clearance from the European Commission in January. I want to thank all of our customers for the overwhelming support they have given us during this process.

I want to especially thank the hundreds of customers who shared their views with the European Commission and the many customers and user groups who volunteered to attend the oral hearing last week and especially those who ultimately came to testify including the U.K. Atomic Weapons Establishment, Ericsson, Vodafone, BBVA, Sabre Holdings, [Polao], Carnegie Melon University, the U.K.’s Department of National Health Services and the Independent and U.K. user groups.

In addition, I want to thank the over 60 United States Senators who recognize the importance of this matter and the United States Department of Justice who shared their views with the European Commission. Last but not least I want to thank Oracle and Sun employees and especially the transaction teams including our tireless advisors on the ground for getting this to a just result.

My guidance today does not include any exceptions from our pending acquisition of Sun Microsystems. We do still expect that Sun will contribute $1.5 billion in non-GAAP operating income in our first full fiscal year of owning Sun. After we close the transaction we will share our detailed guidance with you as soon as we can.

Now let me turn to the guidance without Sun for now. We believe the guidance I am giving today is realistic. I want to emphasize our pipelines continue to be very strong and the close rates I am assuming are more conservative than typical Q3 close rates. For the coming quarter, assuming that exchange rates remain at current levels, we expect there to be an almost 8% positive currency effect on license growth rates and an almost 7% effect on total revenue growth rates but of course that is likely to change.

With that, our guidance for Q3 is as follows: New software license revenue growth is expected to range from negative 1% to positive 9% at current exchange rates and negative 8% to positive 2% in constant currency. Total revenue growth on a non-GAAP basis is expected to range from positive 3% to positive 6% at current exchange rates and negative 3% to flat in constant currency.

On a GAAP basis we expect total revenue from positive 4 to positive 7 at current exchange rates and negative 2 to positive 1 in constant currency. Non-GAAP EPS is expected to be $0.36 to $0.38 assuming current exchange rates, up from $0.35 last year and from $0.33 to $0.35 in constant currency. GAAP EPS for the third quarter is expected to be $0.26 to $0.28 using current exchange rates and $0.23 to $0.25 assuming constant currency. This guidance assumes a non-GAAP tax rate of 28% for Q3 versus 26.6% in Q3 last year. The GAAP tax rate is expected to be 29.3%.

The board again declared a dividend of $0.05 per share. We generated $8.7 billion in operating cash flow over the last 12 months and we are running the business at record margins. We look forward to the completion of the Sun acquisition in January.

With that I will turn it over to Charles for his comments.

Charles Phillips, Jr.

Thanks Safra. Just a few comments on customers. I first also wanted to recognize the organization for doing a great job. All the regions and GDUs and the supporting organizations. Customers are holding onto their dollars a little tighter these days. These deals are very complex and they don’t happen without people really fighting for them so these guys walk through walls and got a good result.

By product area, database Exadata is on fire, nearly tripled sequentially. The pipelines are growing week to week. We are now having some of the initial customers come back and ask for multiple systems which is always a good sign. The main constraint we have right now is just production capacity the field is fighting for them in each region. It is a red hot product and we expect that to continue to have momentum going forward.

Some key regular database wins in the quarter: [GMAC standard] Oracle database, US Airways, ULA for database rack and portioning. We also had an important release in the quarter I should mention; a new release of Oracle Database Vault. Options generally did well in the quarter. I think this is an important option because this is the product that separates administrative rights from security rights in the database and now it has been certified for SAP so SAP support is now available and that is a big market and we expect that to do well.

In the area of middle ware, we had some wins over Microsoft SharePoint using our product WebCenter and we won and beat them at Bank of the [World] in India and McGill University. On our storage platform National [inaudible] bank standardized on our storage suite as that was a win over Tibco. We had a little bit of an edge there since they are already rolling out FlexCube our core banking product for integration after a 12 week run with the concept they selected this as well.

Business intelligence, CIBC Bank selected us over Cognos. Gilead Sciences used our Dashboard with TD Edwards that they already had installed so we are seeing the uptake of the DI Dashboards there that are customized for our applications start to take off as well. In the area of EPM, good wins at Constellation Brands and Kimberley-Clark. At management we had an interesting win at California Employment and Development Department. They are going to use our Identity Management platform to identify constituencies that both take state unemployment and disability insurance and bring those two agencies together using our IDM.

Applications, we had another release of AIA, our integration architecture platform that was release 2.5 with ten new cross-industry process integration packs, or pips, and six new industry specific pips and now we have about 1,000 enterprise services and 100 enterprise objects. That integration between all of our applications was instrumental in winning at Agilysis and New York State Insurance Fund.

In ERP a good win at Pennsylvania State System of Higher Education across 14 individual universities with the SAP there using People Soft Student demonstrations. In CRM we had good wins at Woolworth’s, Capital One Services and Cummings, Semanta Value Chain planning. We had good winds at Land O Lakes, Ingersoll-Rand, Garden Restaurants. Retail merchandising was installed at [Ritelands] and then General Electric Oil and Gas selected Primavera project management platform as the standard.

We are also moving to a new market. We recently bought a company called Sophoi, which has digital rights management so communications business unit has that product and was able to announce the deal and track for intellectual properties and content online so we had a win at Lexis-Nexis based on that platform. Kind of an incremental market they have to track digital rights and then [bill] for it. They also won at [Air Sale].

Lastly, a couple of wins to mention, Marsh selected us for a new policy administration system and ParAccel for Oracle Argus-Safety to manage their safety and pharmacoviligance process. Those are my comments.

Lawrence Ellison

Thank you Charles. Since we are getting closer to closing the Sun deal I want to talk a little bit about our strategy with Sun going forward. What we are not going to do and what we are going to do.

One thing we recognized that Sun just really does not now and is never likely to have the volume to compete in the high volume, low margin business of just selling an Intel server with Windows on it or Linux on it one at a time. We think that high volume, low margin business is a good business as long as you have high volumes. That is something that Dell and HP are very good at and we are going to avoid that business.

Instead, we are pursuing the high value, high performance market. Very large SMP machines like the SPARC Solaris M9000 which we will continue to enhance. We are putting the Solaris as new /cache feature that allows the M9000 to run the Oracle database very, very fast. We will not only be focused on SMP machines which have been around for a long time, though we think those SMP machines are best in class.

We are also going to be building clusters of industry standard machines and SPARC machines. Those clusters are now called private clouds. That is the more fashionable term for clusters. We are using our software, our operating systems, both Solaris and Oracle Enterprise Linux, our virtualization, the ability to dynamically allocate and de-allocate resources which is essential for cloud computing as well as the integrated networking and integrated storage to deliberately complete private cloud to our customers. Our customers will be able to buy high end SMP machines, high performance and high value for high-end private clouds with all of the pieces including processing, storage and networking integrated together with Oracle/Sun software.

We think that will heavily differentiate our offering with the offerings of IBM, HP and Dell. We think we can compete very effectively there and that will deliver high margins and allow us to deliver that $1.5 billion of additional profit in our first full year of having Sun.

With that I guess we are ready to open it up for questions.

Question and Answer Session

Operator

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

Adam Holt - Morgan Stanley

My question is about the database business, a relatively material sequential improvement in the growth rates. Could you talk a little bit about the drivers of that improvement in the quarter and in particular touch on ELA renewals and also some of the recent product cycles specifically the middle ware release and the impact on that release on reaccelerating the growth in the database business?

Charles Phillips, Jr.

I think on the database business people had been putting off some of those ELA decisions and kind of behind on picking up on some of those contracts that happened during the downturn and now some of that is starting to come back. I also think some of the initial work we did on [11G] to get the ISB’s on board takes a little while. That is kicking in as well. So we feel pretty good about the database business and obviously Exadata is helping drive some of that as well.

Operator

The next question comes from the line of Sara Friar - Goldman Sachs.

Sara Friar - Goldman Sachs

Can you talk about linearity in the quarter? Specifically did you see recovery throughout the quarter and hence do you feel like you are entering this February quarter with an ongoing acceleration in spending? Just very briefly on Europe could you talk a little bit about what the lag is to the US that you are seeing?

Charles Phillips, Jr.

I would say this quarter looked more typical as recent quarters I guess and wasn’t any more back end loaded. I think the other thing to note is as the current quarter has started off in pretty good shape, we always have some deals that spill over but it was a little more pronounced this quarter. So just based on the last month or so it certainly feels better but it doesn’t matter until we close it at the end. What was your second question?

Sara Friar - Goldman Sachs

On Europe, it seems like it is lagging the US by a quarter or two. Is there any reason why it would lag by more or less than that based on what you are seeing over there right now?

Charles Phillips, Jr.

That actually has always been the pattern. They tend to turn down six months later and then it takes another six months when the recovery happens as well. Things happen more slowly there. Customers don’t react quite as well. They are not as centralized in their decision making and so that doesn’t surprise me at all.

Operator

The next question comes from the line of John Difucci - J.P. Morgan

John Difucci - J.P. Morgan

My question has to do with the macro environment. You put up numbers here this quarter that were obviously better than we anticipated and you too. Also you gave guidance here that actually looks pretty good, better than I think we anticipated out here. Just curious, is there truly a recovery happening in a meaningful way or is Oracle…I am trying to get a gauge as to whether or not what is happening out there has more to do with Oracle’s execution which is at least over the last several years head and shoulders above many of your competitors or is this a rising tide that may be listing all ships at least in this quarter and into the near future?

Safra Catz

From where we sit it is very hard to tell. Obviously we are definitely seeing customers back buying with extremely wide spread. No giant deals of any sort but lots of very nice sized transactions for every size of company. So we are really seeing a recovery. Now it is true that our execution, our teams are doing very, very well. The products are very, very, very strong and so I think what is happening is we are clearly winning at the expense of others but we do also see the environment significantly improving.

Operator

The next question comes from the line of Heather Bellini – ISI.

Heather Bellini - ISI

I was wondering, you have been talking about how your pipeline has been getting bigger and bigger and after last quarter I would imagine you said the same thing. I guess what I am wondering is in terms of close rates are we starting to see close rates improve and the predictive CIO’s willing to spend their budget improve or is the upside this quarter the fact that after last quarter your pipeline was maybe a little bit bigger than you thought it was going to be and therefore you just hit your close rate target?

Safra Catz

It is a little of both. We did better than the close rates I expected. I still wanted to lean to a more conservative close rate for where we are at. The economy is uneven maybe and we just can’t tell what is going to happen going forward. I continued to use a very low close rate and I expect us to be at least there but our pipelines are really growing and there is an enormous amount of heat around the Exadata product which are also those database and storage software. So there is really a lot of good news on the whole product line which is one of the reasons the pipelines are as they are. Charles do you want to add anything to that?

Charles Phillips, Jr.

The close rates normally in Q3 are a little bit less than Q2 so we plan accordingly. So we haven’t assumed anything heroic and if we do better we do better. The pipelines are growing in each region and certainly the tone of the forecast calls is a little bit better than it was three months ago.

Operator

The next question comes from the line of Israel Hernandez – Barclays Capital.

Israel Hernandez – Barclays Capital

I have a quick question on the vertical market performance. Were there any particular stand outs during the quarter? Did that vary at all by region? Are there any verticals that are seemingly lagging relative to the others?

Charles Phillips, Jr.

I would say communications had a good quarter to what they normally do and it is certainly producing a nice pipeline. I would say there is a good pipeline for financial services. The banks held back for awhile but based on the pipeline of what is already closing for the first few weeks of the quarter even the banks seem to be coming back. So it is uneven because I would say retail probably had a tough time six months ago but their pipeline has come back as well and they have closed a deal already in the first few weeks of this quarter; a fairly sizeable one. If that is any indication on how the first few weeks are going, they look better.

Operator

The next question comes from the line of Brent Thill – UBS.

Brent Thill – UBS

The maintenance business snapped back pretty nicely. You saw accelerating growth rates in the second quarter. Can you walk us through what you are thinking about for the second half of the maintenance business? If I can just ask Larry and Charles a question on Exadata, I think you mentioned you are somewhat capacity constrained. Can you give us a sense of how big you think this business can be? I know you are not going to give us exact numbers but any way you can shape this business or more metrics you think you will give us going forward that would be great.

Lawrence Ellison

Well, we think the Exadata business is going to be huge. By huge, billions of dollars a year in new systems sales not including the maintenance on those systems. How long it takes us to get there remains to be seen. Our overall view of the computer industry is we have been selling components to large customers and the components have been hiring system integrators to glue those components together into complete systems.

Our overall strategy going forward as I mentioned earlier, as a preamble to your question, is not to sell these individual industry-standard components on their own but rather group them together into machines like Exadata where we have processors, networking, storage, storage software, database software, our Oracle Enterprise Linux operating system, all a complete database machine for both transaction processing and data warehousing.

We think that makes it much easier for the customer. They don’t have do all the system integration. They don’t have to buy a bunch of parts and glue them together but instead they buy the box. It is a high margin product for us and a high value purchase for them because they don’t have to spend a lot of money on system integration. We think that is the way customers are going to go forward as they build their data centers; not buying components but buying systems like Exadata.

One of the big reasons we bought Sun is that we wanted to apply that same strategy to middle ware, applications and to the operating systems themselves where we are not going to sell operating systems just for an individual computer but we are going to sell the next generation of Solaris is going to be a cloud addition to Solaris where it manages a group, a cloud, a cluster of these computers that we sell together as a unit. That is highly differentiated, high margin for us and no systems integration required for the customer. How big is that business? We think that is what the computer business is going to look like for large customers going forward. We think that is billions and billions of dollars. That is our business in the future.

Safra Catz

Regarding your maintenance question, our software updates and support obviously that is really our subscribers. Those are our users and they are paying for both support and the right to receive without buying the new licenses or new products. That is a number that is always going to go up because customers feel they are getting fantastic value for it. The second half of the year frankly there is no point in going into too much detail on any of the numbers because within the month frankly we will be giving you new guidance that will include the software parts and of course the hardware parts from Sun Microsystems. So all of you are going to have to redo all of your models at that point. You should expect maintenance for us is really who our customers are and they are renewing at record rates because they are very satisfied with our products and we are advancing just so quickly right now.

Operator

The next question comes from the line of Kash Rangan - Merrill Lynch.

Kash Rangan - Merrill Lynch

My question is on fusion applications, later for some time in 2010 for sale, the management team talked and demo’d the apps in the conference and it looked really good. I was wondering if you have given any thought to how the applications market landscape in the next several years might be disrupted or maybe it is not all that disrupted? How do you look at the applications industry over the next years and what kind of opportunity does fusion applications open up for you?

Lawrence Ellison

I think the big thing for us is we design fusion applications as components. It is a service oriented architecture and it is componentized. Things like order orchestration could be delivered to a customer. My favorite example, Hewlett Packard, which has a lot of orders and takes orders a lot of places in their company. We can coordinate those orders and then deliver them to the different fulfillment centers inside of Hewlett Packard. So all of our fusion apps are componentized and so it is not a rip and replace sales strategy we have with fusion. We can go in and sell you a lot of point solutions. We can sell you a specific application like order orchestration that integrates with your existing SAP systems and your existing Oracle systems and your existing JD Edwards systems and your existing People Soft systems.

So we can do a complete replacement over time and that is our plan but that is going to be a long period of time for a lot of companies. We want them to start with some of the fusion components like order orchestration, like some of our interesting HR incentive management systems. We have a long list of things. They will buy them a piece at a time but they are designed to be easily integrated with what they already have. We think that is going to allow us to sell fusion aggressively out of the box and increase our share as compared with SAP over time.

Operator

This does conclude the question and answer session. I will now turn the call over to Ken Bond for any additional or closing remarks.

Ken Bond

Thank you. A telephonic replay of this conference call will be available for 24 hours. The replay number is 888-203-1112 or 719-457-0820 and the pass code is 7845753. Also a webcast replay will be available through the close of market on December 28th and can be found on our website at www.oracle.com/investors. Please call the investor relations department with any follow-up questions from this call. We look forward to speaking with you. Thank you all for joining us today on today’s conference call. With that I will turn the call back to the operator for closing.

Operator

This does conclude today’s conference. We thank you all for your participation.

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