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Oracle (NYSE:ORCL)

Q3 2011 Earnings Call

March 24, 2011 5:00 pm ET

Executives

Mark Hurd - President and Director

Safra Catz - President and Director

Jeffrey Epstein - Chief Financial Officer and Executive Vice President

Ken Bond - Investor Relations

Analysts

Adam Holt - Morgan Stanley

Brent Thill - UBS Investment Bank

John DiFucci - JP Morgan Chase & Co

Philip Winslow - Crédit Suisse AG

Jason Maynard - Wells Fargo Securities, LLC

Kash Rangan - BofA Merrill Lynch

Operator

Good day, everyone, and welcome to today's Oracle Corporation Quarterly Conference Call. [Operator Instructions] At this time, I would like to introduce Ken Bond, Vice President of Investor Relations, Oracle. Please go ahead, sir.

Ken Bond

Thank you, operator. Good afternoon, everyone, and welcome to Oracle's third quarter fiscal year 2011 earnings conference call. On the call today are 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 annual report 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 or the market price on 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 revision 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.

Before taking questions from the audience, we'll begin with a few prepared remarks. And with that, I'd like to turn the call over to Jeff Epstein.

Jeffrey 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 positive 2% currency effect to both New License revenue and total revenue. In short, Q3 was another excellent quarter for Oracle. In the third quarter, New Software License revenues were $2.2 billion, up 29%, well above our guidance range of 10% to 20% growth. The Americas grew 35% in U.S. dollars, EMEA was up 19% and Asia was up 32%. With each region up 20% or higher 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 $1.6 billion, up 27%. As the Americas grew 40%, EMEA was up 11% and Asia was up 28%. Applications New License revenues were $639 million, up 34% from last year. The Americas grew 26%, EMEA was up 47% and Asia was up 45%. Our Software License Updates and Product Support revenues were $3.8 billion, up 13% from last year. Customer support attach and renewal rates continue at the usual high levels.

Revenues from our Hardware System products were $1.0 billion, while revenues from Hardware Systems Support were $656 million. Our Services revenues were $1.1 billion, up 23%, as we continue to manage this business to profitable margins. Our total revenues were $8.8 billion, up 36% from last year.

Our non-GAAP operating income was $3.9 billion, up 35%. The non-GAAP operating margin was 44% for the quarter. Our non-GAAP tax rate for the third quarter was 25.4%, which was below our guidance due primarily to the extension and catch-up of United States research and development tax credits. Our Q3 non-GAAP earnings per share were $0.54, above our EPS guidance range of $0.48 to $0.50. Earnings per share were up 40% from last year.

In Q3, we repurchased 7.9 million shares at an average price of $31.54 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 $24.3 billion in cash and investments. Our days 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 a record $9.5 billion in free cash flow and a record $9.9 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 Q3. I'll then review guidance for Q4 and turn the call over to Mark. As you can see, we had yet another excellent quarter. We just continued to execute extremely well. We easily 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 by $0.04. So far this year, we've delivered 38% earnings per share growth in Q1, 33% earnings per share growth in Q2. And now, 40% earnings per share growth in Q3 and we've got Q4 still to come.

So the real highlight of the quarter, of course, is our 29% growth in Software License growth, which was strong in both Technology and Applications and strong in every region of the world. You can really see our momentum in our Apps business as we continue to take share from SAP. Applications grew 34% this quarter, off a 21% growth compare from a year ago. So over the last couple of years, our New License revenue for Applications has grown 53% in constant currency or about more than 10x faster than SAP over the same period.

In addition to our strong topline performance overall, we also delivered very strong operating margins. Our operating margins for the quarter was 44%, just about the same as it was last year except this year, includes a full quarter with Hardware business. This quarter, we delivered 55% gross margins on our Hardware business. This is the result of the fact that, really, under the covers of the Hardware number, the Sun products are growing and the non-Sun products that are resold, that we resell are shrinking dramatically.

In addition, we're selling a lot more of the Exadata, Exalogic line and remember that these systems are sold at good margins and also pull a lot of software with them, like racks [ph], partitioning and storage management. Now as I told you a couple quarters ago, we are really no longer able to identify the exact contributions Sun has made to our operating profits this year. But based on our results, we fully expect to exceed our goal of $1.5 billion in operating profit in the first full fiscal year.

Remember, we paid $5.7 billion for Sun, net of cash. And had we paid for Sun based on the HP 3PAR multiple, it would've cost us nearly $140 billion. Don't worry, we wouldn't do that.

Now finally, let me mention on a more somber note, our sympathies for the ongoing plight of the people of Japan. We have, of course, instituted our dollar-for-dollar charitable match. And fortunately, all of our Japanese employees are safe and our building in Tokyo is essentially undamaged. And frankly though, it's too early to be definitive. We do not expect material impact in our Q4.

As we have always said, we are committed to returning value to our shareholders through technical innovation, strategic acquisitions, stock repurchases and prudent use of debt and a dividend. So as you've heard, we did announce today a 20% increased to our quarterly dividend or $0.06 per share, and this would be the third consecutive fiscal year-over-year increase in our dividend.

Now to the guidance. As your remember, we had a spectacular Q4 last year with New License up 15% in constant dollars and non-GAAP EPS up 30% and GAAP EPS up 24%. So assuming exchange rates remain at current levels, which right now is a positive five points, so five percentage currency effect on License growth and on total revenue growth, our guidance for Q4 is as follows: New Software License revenue growth is expected to range from 9% to 19% at current exchange rates or 4% to 14% in constant currency; Hardware product revenue growth is expected to range from 6% to 12% at current exchange rates and 2% to 8% in constant currency, now that doesn't include the Hardware Support revenue. Total revenue growth on a non-GAAP basis is expected to range from 9% to 13% at current exchange rates and 4% to 8% in constant currency; on a GAAP basis, we expect total revenue from 10% to 14% at current exchange rates and 5% to 9% in constant currency. Non-GAAP EPS is expected to be $0.69 to $0.73 assuming current exchange rates, up from $0.60 last year and $0.65 to $0.69 in constant currency, GAAP EPS for the fourth quarter is expected to be $0.56 to $0.60 assuming current exchange rates up from $0.46 last year and $0.53 to $0.57 in constant currency.

Now this guidance assumes a GAAP tax rate of 28.5% and a non-GAAP tax rate of 28%, of course, it may end up being different. And as is in our documents, the lower rate we had this past quarter was the result of a number of things, but mostly the catch-up from the R&D tax credit. There won't be any catch-up in Q4.

Now with that, I would usually turn this call over to Larry for his comments. However, he is sitting on a jury today on a trial that started two days ago. So with that, I will turn it over to Mark for his comments.

Mark Hurd

Thanks, Safra. I won't comment on the Larry jury activity. And I also apologize for my voice, it's just the weather a bit out here. And I -- of course, I've been doing this a long time, Q3 was just a great quarter. Revenue earnings growth both up over 45%. Customers were energized by our product direction. And frankly, we're just simply executing on all fronts. The Software business continues to grow faster than the market significantly.

We saw strength across all regions, industries and product segments. Engineered systems have fundamentally changed the game. The systems actually changed the entire value proposition of both Hardware and Software, which is why all our competitors are scrambling to react.

Now in terms of what pays the bills around here, our top line 29% New Software license growth stands out. That's software interbridge is broad-based, Technology and Applications, every region. Our GBUs, each of these constant dollar growth at 20% or higher. If you look at our Apps number, 34% growth off of 21% last year stands out. Going forward, as usual, we're going to be the only Applications vendor with a modern set of Applications built on modern infrastructure.

Last call I talked about our industry-focused business units and I want to do it again. Telecom, retail, banking, insurance, energy, all had great quarters. We are the only vendor with the industry solutions across a wide range of industries. For our customers these Applications are even more important than ERP and they position Oracle more strategically with customers.

And of course, Exadata continues to sell itself. The price performance ratio with Exadata is just off the charts. When you consider the performance increases obtainable with little or no re-engineering effort to get up and running, it's hard to think about Oracle workload that doesn't make sense on Exadata.

We saw sequential unit and revenue growth of over 50% in Exadata and Exalogic. As we head into Q4, we expect to see even higher growth. The pipeline for Exalogic is building very rapidly as well with customers building out their private clouds with both Exalogic and Exadata.

And yes, we're in the cloud, whether it's collaborating with Amazon, so that customers can launch an entire Oracle software stack on EC2 or whether it's working directly with a very large federal law agency to build out a private cloud, gain a 10x performance increase as they improve their mission and better protect the United States. Public or private, we're in the cloud.

With Exalogic, we have the most high-performance scalable cloud offering out there today. Modern, Java, Linux, standard spaced, virtualized. And unlike a lot of other cloud offering, Exalogic is already shipping and requires no so-called cloud services to get up and running. And we've added over 1,500 sales resources in the last year. With the strength of our product portfolio, we see opportunities out there and we think we can get them by hiring more sales resources.

Again, let me close by saying our performance was broad-based with solid organic growth. Strength across all regions, industries and product segments, which together drew a spectacular quarter for Oracle. With that, I'll turn it back over to Ken.

Ken Bond

Thanks, Mark. Operator, we'll now prepare for Q&A portion of the call, please?

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Adam Holt from Morgan Stanley.

Adam Holt - Morgan Stanley

I wanted to ask about the Application business in particular. It looked like it inflected up in the quarter and I wanted to understand are you seeing an acceleration in new projects? Is it more about upgrading older systems? And maybe give us an update on Fusion, if you could.

Mark Hurd

I'll start and then Safra can fill in. As you know [ph] this is a strong quarter across-the-board, Adam. Europe, Apps was up a little less than 50%. 47% I think was the number, so simply huge. And I think when you compare that with competition, particularly knowing we're going against tough comps. So the position we gained was significant. Now I don't want to stick with Europe. I mean it was broad-based across. We had very strong growth in Asia, good solid growth in the Americas. And again, we got help from our industries as well. Our growth for the industry business units was again roughly in line with that of Oracle. Fusion is coming online. Fusion is coming online. Again, as we’ve talked before, this is not a rip and replace. It's a modular solution that comes on board in various modules. We're now capable of competing with Fusion today. So we're pretty excited about our position.

Safra Catz

Yes. I mean, in answering your question, I'd say, yes, yes. And I think, yes. Which is, it's all of the above, whether it's existing customers, buying additional products that they hadn't bought from us before. Let's say they use the business suite [ph], they buy demand --they buy one of the other product lines, so there’s that. There’s customers upgrading right now to 12, where they pick up some additional modules in preparation. And it's folks getting set up to put themselves in a position to take Fusion when they're ready. So it really is a new project. And it's addition -- adding to existing projects. We did see a turn up some time last year and it continues. It's really the same dynamic we've had for a while, which is customers just buy more, in additional module and et cetera.

Operator

And we'll go next to Brent Thill with UBS.

Brent Thill - UBS Investment Bank

Safra, you mentioned Japan is showing no impact right now. I guess one of the questions is just around the supply chain impact for the Hardware business, if you could just comment on the Hardware business itself. And Mark, if you could also just give us a quick update on Exadata adoption trends in terms of what you're seeing quarter rack, half rack, full rack from your perspective?

Safra Catz

Okay. Well, we've been working with our suppliers, our sub-suppliers, et cetera. We've got, so far, it's all fine, frankly, and good news in general. And we've got A, both supplies, inventories, et cetera. And we don't actually expect there to be a supply chain issue at all for us out in Japan.

Mark Hurd

On Exadata, best my voice will hold out here, pretty broad-based. Good number of quarter racks in the quarter, which we look at as very positive in terms of seeing the future. We did see some adoption of SH-8 [ph] in the quarter, too, which was again very encouraging. We saw repeat buying, which was again very positive for us. We're now in over 80 countries with Exadata so we had a good, broad new customer adoption, upgrade cycle seeding [ph] of quarter racks. And again, as I think we've been very clear, the pipeline is up as well.

Operator

We'll go next to Phil Winslow with Crédit Suisse.

Philip Winslow - Crédit Suisse AG

Just wanted to dig in a little bit more on Exadata and Exalogic. In the press release and on the call, you mentioned that they grew 50% quarter-to-quarter, which is pretty phenomenal. But now you’re expecting an even acceleration from that in fiscal Q4. What exactly is driving that? Is that increasing amount of competitor displacements? And then also Mark, when you compare the initial ramp here of Exalogic to Exadata, what are you guys seeing and maybe what have you learned comparing the two?

Mark Hurd

On Exalogic, I'll take that first. Ramp, probably, as encouraging as Exadata, would be the way I would describe it. I think we probably learned a bit in terms of training and some things to get us started a little quicker. But that said, I think you're seeing the same kind of interest, excitement and adoption that you saw around Exadata. On Exadata, I don't know how else to say this to you. It's just good stuff. There's just no secret here. The stuff works. And when you show up to a customer, Phil, and say, listen, I got a big opportunity for you. You can consolidate lots of infrastructure, whether that's servers, whether that's storage, you can bring it together. You can get a material change in performance. And again, I'm not talking about 10% better performance, 20%, I'm talking better than 2x. I gave you an example of a law enforcement agency talking about 10x. And I just want to say it one more time, 10x. When you show up and tell somebody, I can do something with 10x better performance. And I can do it with our stack of capabilities, i.e. giving you single accountability for service and support. I can save you money while you do it. It's just an extremely powerful value proposition. So when you’re going to customers that have long -- and you know our history with customers, when you have customers that have long experience with Oracle, they know the quality of support that they get from Oracle and then you show up with this kind of value proposition, it makes for a pretty good meeting.

Operator

We'll take our next question from Kash Rangan with Merrill Lynch.

Kash Rangan - BofA Merrill Lynch

One for Safra. Safra, margins look pretty good, actually very good, they're almost to the point where it were for a peak in February quarter without Hardware. So how much higher can margins go? And I guess as a part of that, how much leverage is there left in the Hardware business that can drive the margins higher? And I have a follow-up for Mark.

Safra Catz

Well, I think it's becoming clear that we're going to be able to ultimately bring the margins very close if not even more than they ever were when we were just a Software business. So we still think there is actually quite a bit of room to be honest with you. We're not quite at scale yet. We do still resell some third-party hardware. And so, we actually think it's going to continue to go up. It will obviously be higher than last year's Q4. And ultimately, we don't actually see it topping out yet or even close. So I think we've got a few more -- quite a few more points to go and we have a very clear line of sight how to get there. So things are going to continue to improve and I think they've already improved past where people thought they'd ever be. But I think we're going to get there and we're going to pass even that.

Kash Rangan - BofA Merrill Lynch

That’s great. And Mark for you, the topic of big data seems to be widely debated by some of your competitors. It's become more -- there's more awareness of it. But there's also the competition is saying that in the era of big data, relational databases are overkill, I just want you to respond to that and set the record straight. And how is Oracle positioned in the era of big data? What are your opts [ph] in these puts and takes broadly speaking?

Mark Hurd

Listen, our stuff works. And it's out there today and I think it's easy to make claims. I think it's easy to do all that. But in the end, we're talking about some customers most important things that they do, access to information. And it's serious stuff. And you need show up with stuff that works, stuff that's available, stuff that can be accessible 24/7. And that's the key to what we do. We don't have to show up with a federated set of companies. We have one-stop shopping on our vertical integration, it is our stuff. It is tested. It is engineered together. It shows up and performs. And it gets supported. And I can tell you while it may sound simple the way I described it, when you show up at a customer with that type of value proposition, it is differentiated highly so, and that's what carries the day.

Operator

We'll take our next question from Jason Maynard with Wells Fargo.

Jason Maynard - Wells Fargo Securities, LLC

I got one for Mark and then a follow-up for Safra. First Mark, you’re one year into the Sun deal. So I'm curious, how's the honeymoon going, if you will? And what are you hearing from customers so far after 12 months under Oracle?

Mark Hurd

Well, I'll tell you based on my time, so far, I think clearly, one thing. I mean it's-- there's no shot at Sun in the rearview mirror. But with Oracle, you've certainly taking one issue that did concern Sun customers, which was the viability of the entity. Was the company sustainable? Was the company going to be in a position -- because as you know, many of these customers made commitments and they look to be on this platform for years. And so when they make those decisions they want to know that the company is going to be there and be behind it. So point one is sustainability, I think very positive. Second, I think as Larry has been very clear, there's more investment going into the Technology. There's more investment into Solaris. There's more investment into SPARC. And so from that perspective, the investment, I think, is extremely positive. Third, you get the leverage and the opportunity to now get optimized software with the hardware. You can see Sun technology at the base of Exadata, the base of Exalogic. And even as we try to do work with our M-series, you can see more opportunities. So you combine that with the support capabilities of Oracle, I think what you hear from customers is much more confidence in the overall value proposition. So I'd say positive. Listen, I don't want to make it sound like we don't have work to do. This is a company that had been through several years of turmoil. But when you net it together, I think the overall view is very positive, Jason.

Jason Maynard - Wells Fargo Securities, LLC

Great. And for Safra, first, thanks for not paying 3PAR multiple for your acquisitions, we appreciate that. But you are kind of spoiling us a little bit here on the margin side and the Hardware margins are continuing to move up. So I'm just curious, what are the kind of the puts and takes within the Hardware business that you're seeing and what have you learned now that you've had that piece under your control in terms of how you go to market and what you focus on selling and getting rid of the third-party products? So what's the color there in that line?

Safra Catz

There really are a lot of moving parts. I mean, the first thing we needed to address was our supply chain, frankly, and getting it under control, which it now really is. And really optimizing the size that we are and not being very broadly and widely distributed all over. So part of it is the cost, just the cost of the supply chain itself. Secondly, it's also what we sell. And it's very important, the mix of business is important. I mean it's always, frankly, it's very easy to sell a couple hundred million more revenue in a quarter and decide not to make any money doing it. It's very easy. People will absolutely buy from you things that you are offering too cheaply. We're not in that business. We really are in the value business. We're in the business of selling things that are valuable to customers. And for them, they have to -- is they really understand what it is we're bringing to the party. So the mix of the business is also very important. And then finally, just making sure that the way we go-to-market, we really are focusing on what customers care about and what's important to them, and not a lot of kind of extraneous activities, that though you spend a lot of money doing, are not necessarily really meeting the needs of customers. So we continue to invest in the things customers care about, which frankly is R&D, support and high quality, and some of the software products. Also, by the way, we got from Sun, Java, et cetera. These are areas of importance to our customers. And that's really what we spend money on. And I think now, actually, in Q4, you'll finally start to see -- you'll start to see a real growth pattern here for the business because though we still have some third-party hardware that we are reselling, it's a much smaller percentage than it used to be. And as that continues, as now we start to actually really grow the Sun intellectual property hardware platform, that's where margins will continue to improve.

Operator

And we have time for one more question. We'll take our last question from John DiFucci with JPMorgan.

John DiFucci - JP Morgan Chase & Co

Actually, I just have two quick ones. The first one is really specific to Oracle. Software license has been better than expectations for the last several quarters. But this quarter, you put a Software License that's much better than what seasonal trends have been. And I'm talking seasonal trends if you back out foreign exchange and you back out acquisition effects. And as you know, as Mark mentioned, Software License is really the core of Oracle. I mean, you’ve got a lot of cores, I guess, right now, but that's where your bread is buttered. And from my calculations, you typically do when you back out foreign exchange and acquisitions, do sort of flattish License revenue from second to third quarter. This quarter was up close to 10%. I'm just wondering, what do you owe that to? What's happening? What was different this quarter? Something happening in the environment or is it something -- is more Oracle specific?

Safra Catz

I would say from, and Mark, please comment, we definitely have company-specific momentum. The Oracle Customer business center is constantly packed. Customers are very interested in our new offerings. Customers are in a position to make investments and they're making them with us. There's no question that we are becoming more important, more popular with our customers. I think we've really consistently delivered on our promises and they're buying more, whether they're buying software to go with Exadata or they're buying more applications or they're buying -- they're making standardization decisions in the Middleware area. We're just seeing more and more repeat buying, increased buying. And I can't comment on the economy, you know we never do, but we definitely have, at least customer-specific momentum, really, on all fronts as Mark said in what he spoke.

Mark Hurd

I have a hard time adding to that. I think, one, I would be very careful not to take any abstraction to the macroeconomy based on what we're doing. I think we have now a broader portfolio. And when you have customers who are generally happy and when you go in -- and then we have customers who believe in our technology. And when you can show up with incremental opportunities for the customer to add to that portfolio, that's where that growth comes from. And we have the opportunity now to cross sell many things to the same customer. And when you do that and you have a relationship with the customer and you deliver for the customer, you get more at bats. And when you do that, going back to get, best place to get the second order is the place you got the first. And I think that's what you see in Oracle today, an opportunity for us in many accounts and we saw it again in Q3. Customers that we saw in Q2 showed up again in Q3 with opportunities for us to do different things than we did in Q2. And to Safra's point, we now show up with capabilities like Exadata, Exalogic, we can help our customer build out a private cloud, we can help customers with their analytic solutions, their OLTP solutions. We can help them with their vertically-specific solutions in their industry, plus their software and application infrastructure. It gives us -- and when you add the hardware mix to it, we just have a lot of opportunities to cross sell. Now I will say on the other side of it, because of the portfolio, we are looking to add to our sales force. We are looking to add reps. And if you know of very -- any of you on this call, that know of quality, talented people, please send them my way.

John DiFucci - JP Morgan Chase & Co

But if I might just add just one quick last one here. And I know Safra, you said you don't like to comment on the economy, but you do have a unique perspective given the mass and the success of Oracle. We continue to wonder about the macro backdrop in Europe and Oracle continues to put up good numbers there. And this quarter shows the best constant currency growth so far this year against what looks to be the toughest comp so far this year. So can you comment on what you expect to see in this region going forward and how that affects your guidance?

Safra Catz

I really can only extrapolate from our most recent experience. Things look very good for us as a company and at least what we have, people appear to want to buy. So, so far, so good. We're optimistic. We’re always very conservative. We don't lose our heads, but things have been going very, very well. Q4 is -- we had a fantastic Q4 last year, so we have a tough compare, but we remain extremely optimistic.

Operator

And this concludes the question-and-answer session. At this time, I would like to turn the conference back to Ken Bond for any additional or closing remarks.

Ken Bond

Thank you, Anne. The telephonic replay of this call will be available for 24 hours. The replay number is 888-203-1112 or 719-457-0820 and the passcode is 8073687. Please call the Investor Relations department with any follow-up questions from this call and we look forward to speaking with you. Thank you all for joining us today. And with that, I'll turn the call back to the operator for closing.

Operator

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

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