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Oracle Corporation (NYSE:ORCL)

F2Q2011 Earnings Call

December 16, 2010 5:00 pm ET

Executives

Ken Bond - VP, IR

Larry Ellison - CEO

Safra Catz - President

Mark Hurd - President

Jeff Epstein - CFO

Analysts

Brent Thill - UBS

Heather Bellini - ISI Group

Adam Holt - Morgan Stanley

John DiFucci - with JPMorgan

Mark Murphy - Piper Jaffray

Sarah Friar - Goldman Sachs

Kash Rangan - Bank of America/Merrill Lynch

Phil Winslow - Credit Suisse

Operator

Good day, everyone, and 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, Oracle. Please go ahead, sir.

Ken Bond

Good afternoon, everyone, and welcome to Oracle's second quarter fiscal year 2011 earnings conference call. With us on the call today are Chief Executive Officer, Larry Ellison; President, Safra Catz; President, Mark Hurd; 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 the 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 affect these forward-looking statements.

We encourage you to review our most recent reports on Form 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 to vary or the 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 any revisions to 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 Investor Relations website. We will begin the call with a few prepared remarks before taking questions from the audience.

With that, I'd like to turn the call over to Jeff for his opening remarks.

Jeff Epstein

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

This quarter, foreign exchange rates resulted in a negative 2% currency effect to both new license revenue and total revenue. In spite of this headwind in both U.S. dollars and constant dollars, we beat the high end of our guidance range for new license revenue, total revenue, and earnings per share with record earnings per share for the second quarter. In short, Q2 was another excellent quarter for Oracle.

In the second quarter, new software license revenues were $2.0 billion, up 21%. The Americas grew 32% in U.S. dollars, EMEA was up 5%, and Asia was up 21%. With each region up double digits on a constant dollar basis, our results continue to underscore the strength and diversity of our business and the quarter was not dependent on any unusually large deals.

Technology new license revenues were $1.4 billion, up 21% as the Americas grew 36%, EMEA was down 1% in U.S. dollars, but up 7% in constant dollars; and Asia was up 27%. Applications new license revenues were $579 million, up 21% from last year. The Americas grew 26%, EMEA was up 23%, and Asia was down 1%.

Our software license updates and product support revenues were $3.7 billion, up 12% from last year. Customer support attach and renewal rates continue at the usual high levels. Revenues from our hardware systems products were $1.1 billion, while revenues from hardware system support were $686 million. Our services revenues were $1.2 billion, up 24% as we continue to manage this business to profitable margins. Our total revenues were $8.6 billion, up 47% from last year.

Non-GAAP operating income was $3.8 billion, up 33%. The non-GAAP operating margin was 44% for the quarter. Our non-GAAP tax rate for the second quarter was 28.5%. Our Q2 non-GAAP earnings per share were $0.51, $0.05 above the high end of our EPS guidance range of $0.44 to $0.46. Earnings per share were up 33% from last year.

In Q2, we repurchased 9.1 million shares at an average price of $27.35 per share for a total of $250 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 $24.8 billion in cash and investments. Our day sales outstanding improved again to 46 days, compared to 47 days last year. And is a testament to the quality of our receivables, the quality of our customers, and the effectiveness of our collection efforts. Finally, we generated $8.7 billion in free cash flow and a record $9.1 billion in operating cash flow during the last four quarters.

Now, I'll turn the call over to Safra.

Safra Catz

Thanks, Jeff. I'll briefly comment on our non-GAAP results for Q2 and then I'll review the guidance for Q3, and turn the call over to Larry and Mark.

As you can see we had another excellent quarter on top of a truly amazing Q1. We, as Jeff mentioned, exceeded the high point of our new license guidance. We beat the high-end of our total revenue guidance and we beat the high end of our EPS guidance to by $0.05. Even excluding a payment for legal fees, we beat the high end of our EPS guidance by $0.04.

The strength in the quarter was very broad based, as you can see with technology growing 23% and apps growing 22% in constant dollars. And all geographies really reported double digit growth for new license sales. The Americas in particular reported spectacular results with 32% growth, highlighted by a 36% growth in technology with Fusion Middleware sales leading the way. Europe was great as well, with 31% apps growth.

You can really see our momentum in our applications results as we continue to take share from SAP. Their most recent new license revenue is actually down 14% from two years ago, while ours has grown 23% over that same period. Sun Hardware Systems was within our guidance, and this quarter we saw sales growth for Sun hardware products as well as higher gross margins, which were 53% for the quarter.

In addition to our strong top-line performance, we also delivered very strong operating margin. With Sun included for the full quarter, our operating margin was 44%, substantially higher than our peers. Actually, our margins are 1500 basis points higher than SAP's operating margins even though we are (inaudible) hardware. At this rate we could be back at pre-start operating margins quite quickly.

Before we turn to guidance for the upcoming quarter, let me just remind everyone once again that our plans for the Sun business are based on a more profit-aware model. Once we reach the one year anniversary, you wouldn't be able to see the hardware growth off a more meaningful baseline. So with that, assuming exchange rates remain at current levels, which right now is a positive 1% currency effect on license growth and 1% positive on total revenue growth, our guidance for Q3 is as follows. New Software license revenue growth is expected to range from 10% to 20% at current exchange rate and 9% to 19% in constant currency.

Hardware products' revenues are expected to be around $1.1 to $1.2 billion and that does not include the hardware support revenue. Total revenue growth on a non-GAAP basis is expected to range from 31% to 35% at current exchange rate and 30 to 34% in constant currency.

On a GAAP basis we expect total revenue from 32% to 36% at current exchange rate and 31% to 35% in constant currency. Non-GAAP EPS is expected to be between $0.48 and $0.50 assuming current exchange rate, up from $0.38 last year, and 48% to 50% in constant currency. GAAP EPS for the third quarter is expected to be $0.34 to $0.36 assuming current exchange rate and 34% to 36% in constant currency. This guidance assumes a tax rate of 30.5% and a Non-GAAP tax rate of 29.5. Of course, it may end up being different. And the Board again declared a dividend of $0.5 per share.

Now before I turn the call over to Larry, I want to congratulate him for driving his sail boat to a front place ranking overall for the year.

And with that it's your turn, Larry.

Larry Ellison

Thank you, Safra. Well, of course the important thing around here is sailing, but right behind that is software and hardware. And I'd like to talk about our strategy and our server business specifically. Our goal is to become number one in the high-end server business for both Online Transaction Processing and Data Warehousing, both of those segments. We are not interested in the low margins commodity segment of the server base; we are focused on high-end OLTP, high end data warehousing, where the margins are good and we can have a highly differentiated product.

Right now our Sun servers, our number's really behind IBM and HP and our high-end server business. We think IBM's hardware and software technology is quite competitive, while HP's big servers are slow, expensive and have little or no software value add. That makes HP extremely vulnerable to market share losses in the coming year.

Over the last year or so, we've introduced three new families of high-end servers; Exadata, Exalogic, and this past quarter SPARC Superclusters. All these new high-end servers are engineered to run our database and middleware software much faster than anything from either IBM or HP. For example, this past quarter our new SPARC Supercluster technology ran the industry standard benchmark for online transaction processing called the TPCC benchmark. Our SPARC Superclusters ran that industry standard OLTP benchmark at 3 million transactions per minute, shadowing IBM's old record which they set on their fastest P7 and passed three of their fastest P7s at 10 million transactions per minute.

So let me make this clear; Sun Oracle, 30 million transactions per minute; three of those P7s, 10 million transactions per minute. With HP's best ever, it did the best performance a distant third at 4 million transactions per minute. In data warehousing it's not uncommon for our Exadata Machine to be ten times faster than the best of the competition.

And IBM's purchase of Netezza and EMC's purchase of Greenplum Technology is not likely to threaten Exadata sales for lots of reasons, but mainly because Exadata is much faster than either of those two technologies. And both in the case of Exadata and in the case of Greenplum, the customer has to rewrite their applications to run on those machines.

So Exadata pipeline continues to grow rapidly, even though IBM brought Netezza and EMC has launched Greenplum. And the Exadata pipeline is now approaching $2 billion.

We expect overall that our new generation of Sun machines, Exadata, Exalogic, and SPARC Superclusters will enable us to win significant share in the high-end server market and put it into the number two position behind IBM very, very soon. Then we'll fight it out with IBM for the number one spot.

And I'll turn it over to Mark.

Mark Hurd

Thanks, Larry. I spent the last three months speaking with customers. I started Oracle the week before Oracle OpenWorld. I just returned last week from Brazil from Oracle OpenWorld Latin America, where we had 12,000 customers. This week we have Oracle OpenWorld Beijing. It's taking place really as we say, where there are 13,000 customers attending. In total we had nearly 60,000 customers at these three shows.

Q3 was a great quarter for us because our customer base is very enthusiastic about the direction of Oracle's product portfolio. Earnings grew 33% this quarter and our margin performance made clear there's a ton of leverage in this business. I want to focus on our opportunities to grow revenue significantly over the next couple of years.

You can see our top-line momentum, 21% new software license revenue. We had a great quarter across the board. Technology and applications was excellent, more than 20%. All geographies had double digit growth in constant dollar, and our industry-focused businesses were up triple digits.

The deal volume was spread across companies of all sizes and we had a very healthy number of customer wins in the public sector as well. The strength in the quarter was very broad based. Our customers reacted to the fact that we're delivering game-changing technologies that matter to our customers. Exadata and Exalogic are creating tremendous buzz in the industry and among our customers. All of our competitors, as Larry mentioned, are reacting to us (inaudible) relating to integrated systems.

We’ve got 295,000 database customers that can run their Oracle work load order of magnitudes faster by deploying Exadata. Exadata customers are experiencing immediate performance increase, measured in multiples, not percentages. Customers are seeing 15 to 50 times the improvement with Exadata.

We are seeing a lot of enthusiasm and beginning to build order backlog for Exalogic which would be available next quarter in both Intel and SPARC versions. We have 150,000 middleware customers, many of them using our market leading WebLogic app server. All of them are (inaudible) Exalogic.

We made more announcements relating to Sun's core technologies, specifically Solaris and SPARC. As an early indicator, we entered the quarter with a record hardware backlog. Last, our industry-focused businesses are creating strategic advantage for Oracle because no other large vendor is doing pre-packaged industry-specific solutions.

With that I'll turn it back to Ken.

Ken Bond

Thank you. Operator, can we now go to the Q&A please?

Operator

(Operator Instructions) We'll take our first question from Brent Thill with UBS.

Brent Thill - UBS

Question for Larry. With Exadata, are you starting to see a halo impact on adoption of the broader oracle suite? And you also mentioned, the pipelines quickly doubled to $2 billion. Can you just give us a sense of how the close rates are doing?

Larry Ellison

Well, the close rates are doubly improving and I think you are going to see a significant jump in Exadata sale going from Q2 to Q3. So this pipeline grew very, very rapidly. And again, there's a lot of interest. But because it's a new product, people were running a lot of benchmarks, they are trying it, they buy a small machine first. And we are beginning to see some significant re-buys, and a lot more customers translating their interest into purchases. And I think we are going to sell a lot more Exadata in Q3 than in Q2.

I think in terms of the halo effect, it's a general recognition now that you buy these high-end servers, you usually buy them to run specific software. And we believe that we do a good job of engineering the software and the server at the same time to make sure they work well together.

We have a huge competitive advantage over HP and IBM. Now, IBM does have a lot of software; HP does not. That makes them particularly vulnerable. But the notion of engineered systems, hardware and software that works together, I believe is going to dominate the high end of the business. By the way, it's already dominating the low end of the business, because I suspect you use either an Apple iPhone, an iPad or an Android, where specifically in the case of iPad and iPhone, they were engineered to work together, the Android not so.

And you decide which is the delivering a better overall user experience between those two products in the low end.

Operator

We will go next to Heather Bellini with ISI Group.

Heather Bellini - ISI Group

You clearly have a lot of irons in the fire right now with Fusion Apps coming up and Exadata success that you just mentioned. I wanted to hone in on Exalogic for a second. And I was wondering if you could share with us early feedback from customers. And then specifically, I was wondering how you would expect the product to ramp versus Exadata. Given the success that product has had, it would seem like it would help pave the way for potentially a faster uptake.

Mark Hurd

I think you said it right. I think the Exadata experience actually benefits our Exalogic launch. As I mentioned in my comments, we've got a very large WebLogic base. And just to give an idea of the opportunity here, we can go in with an Exalogic solution and actually anybody that's got more than a dozen licenses decrease their cost, while in some cases increasing their performance over 50%. So we have matured the use case. We think we know its targets are, as I mentioned.

And the Exadata experience is a big deal for us, because it really prepares us to sell hardware and software that's engineered together. So we're bullish on, as you pointed about, multiple irons in the fire. We have a lot of talent here to manage the opportunity.

Operator

We will our take next question from Adam Holt, Morgan Stanley.

Adam Holt - Morgan Stanley

I wanted to drill in a little bit on the technology business and in particular Fusion Middleware. You mentioned, Safra, in your comments as an area of strength in the U.S. What do you think is driving that? Specifically, can you touch on where you think you are in the 11g cycle and how important Fusion Applications coming up next year are for people upgrading Middleware now?

Larry Ellison

We've been in the middleware business for a very, very long time, and we entered that business with a combination of innovation and acquisitions. We had made middleware acquisitions. We weren't satisfied just to resell what we bought. We actually rewrote a lot of what we bought.

So we had a unified architecture where we have a single common metadata repository for all the components of our middleware. And whether this is SOA Suite or for that matter BI, Business Intelligence, it's all Java-based. It's all rewritten. It's a single integrated suite where you can buy a piece at a time, but all the pieces fit together. You will hear that theme over and over again.

With Release 11 of our Middleware, everything has now been rewritten. All the pieces operate off a single metadata library. It's a much better user experience, because you can attach our entire Middleware suite with a single file. Versus, if you take IBM WebSphere, IBM WebSphere is literally dozens, if not more than a 100 separate products all with separate patching technologies.

So we think the fact that we have an integrated suite gives us a huge competitive advantage over IBM, and we are winning share there very, very rapidly. We'd expect the advantage we have in database, you will see over the next five years also moving to Middleware.

Operator

We will go next to John DiFucci with JPMorgan.

John DiFucci - JPMorgan

I have a question in regard to Europe. Europe was better than at least we thought it would be. I'm not sure if that's an Oracle thing or if that's just Europe maybe isn't as bad as it sounds like it can get. My question has more to do with the Apps business. That was really strong, granted it was relatively easy comp, but there was still a really strong number, especially when you look at your competitors there.

And you have been gaining share against SAP, and that's been showing up in the numbers over the last couple of years. But this almost seems like it's an acceleration of that. Is that actually happening now, or are we seeing a pickup in the general environment for Apps spending in Europe?

Mark Hurd

I am not an economist and I wouldn't want you to extrapolate anything about Europe other than we are doing well there. And I think when you look at Europe, it was broad based when you look at the App business across Europe. Again, I want to reemphasize this was not singular to a deal. It was not singular to a country. It was pretty broad based against the countries where we have been gaining share frankly over the past several years.

So when you make the comment, I just want to make sure it's clear. This has been a really steady progression. As I look back at the history of Oracle gains in Apps in Europe, it has been sort of one quarter after another in a pretty steady beat. And I would say this was a continuation of that.

And again, across countries, across apps, we had some very nice help from our industry GBUs in the quarter in Europe that helped as well.

Larry Ellison

I'd like to just reemphasize what Mark said earlier in his prepared remarks that we have a wonderful set of industry-specific applications that will often lead to fairly large deals in telecommunications, in banking, in retail and in other places. And that's really a unique value preposition vis-à-vis our primary competitor, SAP. They don't have those industry-specific applications. That’s helped us a lot to establish ourselves in a number of industries.

The other thing is Fusion is right around the corner, and our customers are seeing us deliver this new technology. And I think it's making it very, very comfortable with not just only moving to Fusion right away, but continuing their investment in Oracle Applications. We are giving them a choice with vertical applications, with continued investment in the E-Business Suite, PeopleSoft products and the Siebel products and this whole next generation of Java-based Fusion applications.

The investment that we're making in that trifecta of technologies is again creating a level of comfort where our big customers are willing to continue to invest and in fact increase their investment in Oracle Applications.

Operator

We'll go next to Mark Murphy with Piper Jaffray.

Mark Murphy - Piper Jaffray

How frequently is an Exadata deployment resulting in the displacement of a competitor's products? For instance, if you see a preexisting storage footprint or backup technologies or commodity servers that are being unplugged and subsumed into the Exadata box?

Mark Hurd

This is the best I can give you, because it's not always a perfect science. About 70%, 75% of the time, we are displacing something 25% to 30% of the time, this is a consolidation. So you could think of it as a net new play. I think to also add to Larry's earlier points about Exadata, just so you get some context here, we've sold Exadata now in 50 countries. We've also got about 30%, 35% customers have made a second purchase from us.

So you are beginning, to Larry's point, to see repetition here. You're beginning to see breadth of distribution here. You're seeing us displace competition, but also create some new opportunities at the same time.

So back to Heather's point, we've learned a lot about this. So as we launch Exalogic, we feel we can take those learnings and accelerate our launch.

Operator

We'll take our next question from Sarah Friar with Goldman Sachs.

Sarah Friar - Goldman Sachs

People have talked a lot here on the topline, but the margin outperformance was also a real highlight. Is that a level we can build from as we look forward here in this February, or is there anything non-repeatable or anything you'd flag to make sure we don't get our expectations too far ahead of ourselves?

Safra Catz

In general, it's a business. The only non-repeatable thing in there is the thing I mentioned during my comments, which is we did get a $120 million legal settlement for fees, and that will not be repeating any time soon. But as far as hardware margins or in general operating margins, obviously this is something we've done for many years and clearly we're on a continued benefit both from product mix and scale, which works to our benefit as we continue to grow.

Sarah Friar - Goldman Sachs

In your pipeline, could you give us a rough percentage of how much is data warehousing deployment versus more of the pure consolidation you are talking about vis-à-vis an HP or an IBM?

Larry Ellison

When you add vis-à-vis HP or IBM, that changes. But roughly think of 60% of what we're doing right now is data warehouse. And I think there is a belief that most of it is. And we're starting to see a movement of Exadata into OLTP now. I think that would be logical. That's what you would expect. And that's the trend we're seeing.

Operator

We'll go next to Kash Rangan with Bank of America/Merrill Lynch.

Kash Rangan - Bank of America/Merrill Lynch

I was wondering if you could comment on what are the implications for the database license revenue growth rate based on all the Exadata shipments that you put through the last few quarters. It looks like customers are just beginning to use some of the features of Exadata using all DLA licenses. I'm just wondering what is your visibility into the pipeline for database licenses as you look at Exadata shipments that you've been able to put through.

Mark Hurd

I think a couple of quarters ago, someone noticed that our technology license sales were accelerating nicely, and one of the things we pointed to was Exadata. So we think that Exadata is going to be a nice turbocharger to our overall database license businesses. As we take share from Teradata, as we take share from some of the big IBM P7s, HP Superdomes, I think across the board our database business is going to get stronger along with Exadata.

Kash Rangan - Bank of America/Merrill Lynch

Larry, you wrote about the topic of big data recently, how is Oracle equipped to handle big data, terabyte scale databases and data warehouses?

Larry Ellison

Well, again, we think that one of the things that's very attractive about Exadata, it certainly scales to petabytes, and certainly with [ph] our SPARC Superclusters. You put all of these things in perspective. Exadata is an Oracle-specific database machine that runs the database incredibly fast, and it includes obviously the servers, very, very fast network and the average [ph] specific storage.

Exalogic is really designed to run our middleware and very specifically modern middleware Java incredibly fast. And then our SPARC Supercluster is our new generation of general purpose computing, featuring SPARC and Solaris, it runs everything, database, middleware, all of your applications, all the stuff you've got running on existing SPARC servers you can migrate to SPARC Superclusters.

All of those machines are designed to scale up and be used, if you will, in gigantic clouds whether they are private or public. And I'll handle petabytes of data, but handling petabytes to data is two-fold. One is you have to have scalability. The other is you have to have built-in fault tolerance. When you're running one of these big clouds, you can’t imagine how disappointed people get when the cloud stops working. And all of these people just can't get their data.

So one thing that's common across Exadata, Exalogic, and SPARC Superclusters is that it’s a fault tolerant parallel architecture. So one component fails, everything else keeps running. That gives us not only scalability and performance, which we normally talk about, but also gives us the third key element, which is full tolerance, which HP doesn't have and IBM doesn't have, because they don't really have parallel architectures for online transaction processing.

Mark Hurd

I can’t help but add to it that it's also the cost of the scale that's a big benefit. You get in traditional data warehouses, the way you drive performance in traditional big petabyte data warehouses, is you throw a lot of technology at it. So you string out all this data, lots of discs and then you put a lot of nodes against it trying to get the data.

The secret sauce in Exadata is bringing the Smart to the data as opposed to the data to the Smart, and it changes. That's why I make the comments about these 15X to 50X improvements. These are huge, because you can take that either in performance or you can take it in lower cost, while you do everything Larry just said. It's again changing.

Operator

We'll take our next question from Phil Winslow with Credit Suisse.

Phil Winslow - Credit Suisse

Just wanted to focus back on the database business for a bit. Obviously you continue to see good growth there in terms of software licenses. What continues to drive that? Database held it up very well in the downturn, and continues to grow nicely as the apps business also continues to reaccelerate. Is it core database, is it add-ons? What's the feedback you're hearing from customers?

Larry Ellison

Again, we think our technology is getting faster and more reliable and more secure at a higher rate than our competitors' technology. So we think that the differentiation we have in scalability and performance, and security, and reliability, and then costs puts us in a much stronger position when we're competing with IBM at the high end, Microsoft in the low end. In database, and in middleware, and as far as applications, we think -- I mean I am not sure you want me to go through it here, but we think there are lots of reasons why we're continuing to gain share every quarter over the last few years, against SAP.

And I outlined kind of our three way strategy, to have inventory specific applications, where in a lot of cases a telco is running pretty much only Oracle software. And we're seeing some banks now making those kind of commitments to Oracle's offer up and down the stack. You know, SAP just doesn't have these applications.

Next is our commitment to protecting customer's investment in their existing Oracle technology, whether it's PeopleSoft, Siebel, JD Edwards, or E-Business Suite, and then make this huge investment. I think they're coming down very quickly in next calendar year. We're going to be talking a lot about fusion. We've got this new generation of applications by the way that runs on premise, and in the public cloud, as well as private clouds on premise or public cloud -- nobody has this.

SAP Business ByDesign runs just in the cloud. SAP's traditional applications run just on premise. Fusion runs both places. You decide where you want to put this. You can't do that with Salesforce.com. You can't do that with Workday, a lot of these guys. So we got this brand new extremely modern Java-based suite of applications called Fusion that runs in the cloud, runs on premise, it’s going to dramatically strengthen our position against our cloud based competitors like Salesforce and Workday, and our traditional competitor SAP. So we think, you're just seeing the beginning of us gaining share on applications. That's going to really take off next year.

Operator

And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Mr. Bond for any additional or closing remarks.

Ken Bond

Thank you operator. Telephonic replay of this conference call will be available for 24 hour. The replay number is 888-203-1112 or 719-457-0820 and the pass code is 9062899. Please call the Investor Relations department for any follow-up questions from this call and we look forward to speaking with you.

Thank you all for joining us on today's conference call. And with that, I will now turn the call back to the operator for closing.

Operator

That does conclude today's conference. We thank you for your participation.

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