Oracle Corporation (ORCL) Q3 2010 Earnings Report, Transcript and Summary

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

Thank you. Good afternoon everyone and welcome to Oracle's third 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 affect 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 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 the results of any revisions of these forward-looking statements in light of new information or future results. 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 the call with a few prepared remarks before taking questions from the audience. With that I would like to turn the call over to Jeff Epstein for his opening remarks. Jeff?

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. First, a comment about foreign exchange rate movements. Excluding Sun the actual currency benefit we saw this quarter was less than our guidance by approximately 2% for both new license revenue and total revenue. However, even with currency tailwinds being less than anticipated we were able to drive solid results this quarter as we beat our new license revenue guidance, beat our total revenue guidance and were at the high end of the EPS range with record Q3 earnings per share. Q3 was a solid quarter. Before reviewing our income statement I would like to remind everyone that our guidance from last quarter excluded Sun. In discussing revenue I will provide revenue results as reported and for some key growth rates I will exclude Sun revenue to align the results to our guidance from last quarter. In the third quarter our new software license revenues were $1.7 billion including $46 million from Sun. New software license revenues were up 13% and up 10% excluding Sun. This 10% growth beat the high end of our guidance range, calling for 9% growth. The Americas grew 22%. EMEA was up 3% and Asia was up 12%. Our results continue to underscore the strength, balance and diversity of our business and the quarter was not dependent on any unusually large deals. Technology new license revenues were $1.2 billion up 11% as the Americas grew 20%, EMEA was up 2% and Asia was up 9%. Applications new license revenues were $477 million, up 21% from last year. The Americas grew 26%. EMEA was up 7% and Asia was up 29%. Our software license update and product support…

Thanks Jeff. As you can all see we had another fantastic quarter. I would like to first address our performance excluding Sun as this relates directly to the guidance we provided last quarter and then I will highlight a few points related to Sun. For starters, as Jeff mentioned we exceeded the high point of our new license guidance with 10% growth in software licenses excluding Sun. This clearly shows substantial strength in the database, Middleware and applications business. We also beat the high end of our total revenue guidance with consistent strength in our update and support renewals. Results for our application business were nothing short of stunning. We grew 21% while SAP continued to shrink at a double digit pace. Our applications business is doing very well in all regions and in all verticals and it is truly no wonder SAP is so unhappy. In addition to our strong top line performance we delivered very strong operating margins. With Sun included our operating margin was 45%, substantially higher than our peers including IBM. Our operating margin remains much higher than SAP’s targets and we are now selling hardware. Regarding Sun, as you all know the transaction closed at the end of January so our Q3 results for Sun reflect a one-month period of February which would have been in the middle of their Q3. Sun’s revenues for February were $596 million which was far better than we expected and clearly demonstrates to us that customers are responding well to the acquisition. We believe the Oracle/Sun integration is off to a very strong start. We are moving forward quickly to implement the operational changes we described for you on January 27th and we continue to expect Sun to contribute $1.5 billion in non-GAAP operating income in fiscal year 2011…

Thank you Safra. I thought I would review our strategy in two markets where we are not currently the market leader. The first market is high end servers where IBM is our primary competitor and the other is business applications where SAP is our primary competitor. Let me start with servers. Since we acquired Sun we have embarked on putting together clusters of some hardware running with our database and Middleware software. That is, we have a collection of some machines interconnected by a modern antenna band network talking to storage also connected to the servers using a modern antenna band network. Exadata is the best example of this clustered architecture where we have collections of machines, storage and networks all built together with the software [in tune] for the software. What we have been able to do with Exadata and there will be other clusters like Exadata coming out for Middleware applications pretty much all the software that we sell. It is not uncommon for an Exadata benchmark to be going up against a big IBM P-series machine to beat them by a factor of ten because they just don’t have a clustered architecture. They have stuck with kind of an old fashioned SMP architecture for transaction processing. We are taking advantage of new technologies. Not just [inaudible] by the way but Flash, very large scale integrated memories and you will see all of that has allowed us to deliver stunning performance using if you will commodity parts. Not only do we run much faster than the IBM P-series but also our architecture gives clusters around multiple servers, multiple pieces of storage [inaudible] there is no single point of sale here so it is much more reliable while delivering this fantastic performance. Finally it is much lower in cost…

Thanks Larry. [The Sun] organization has done a great job integrating the Sun reps quickly. They executed very well as you can see. Within days and at most weeks we had the accounts, territories and cost plans all assigned. Reps quickly got back in front of customers and that was a key factor in the quarter and they stayed focused and built pipelines and did a great job all the way around the world. All the customer data has been converted over to Oracle Systems and pipeline and forecasting processes have been standardized. On the customer side I would say customers, I think the best word is they are “intrigued” with our strategy. A good example is we had a CIO summit yesterday in Atlanta. We were expecting about 125 CIO’s we invited. We got over 175. 85% of them traveled to get there from surrounding states and 91% of them were first time attendees to this type of event. So we are getting our competitor’s customers to come and hear what we have to say. They just want to know what is happening. I think they sense there is some sort of transformation in the industry that is possible based on what we are doing. They want to know exactly what we are planning. We are going to do a lot more of that. We are just getting started. We have four more CIO summits and CFO summits in the next three months so we are getting our frequent flyer miles in but we need to take advantage of this while it is there because we can get an audience with almost anyone right now. That is wind at our back in that respect. By product area I am going to start off with database. Exadata as we have…

Thank you Charles. Operator, we will take our first question please.

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

You mentioned you are ahead of schedule in terms of the execution on Sun. I was hoping maybe you could drill down a bit on where you think you are actually ahead of plan. Now that you are a little bit deeper into the integration where do you see some of the upside opportunities? In particular, what do you think you can do with maintenance revenue in the Sun base?

I think really we are ahead on sort of all fronts operationally. Both our business practices are being adopted really as of day one and just operationally the way we work with our customers has already changed. As you know we have moved to a build to order model versus a build to stock model. We are not encouraging stocking in general even with our resellers such that customers can order exactly the box they want and that way we can optimize for the time it takes them exactly that box. That obviously also reduces any kind of obsolescence or inventory issues for us. That is really in place now for awhile and really moving along very, very quickly. The regular contractual terms, etc. and the way we are working with our partners many of them recognize that the old model really didn’t work for either them or for customers and surely not for Sun and are very, very open to readjusting those and many of those have already been completely adjusted; faster than I originally expected. As far as maintenance or product support, it turns out that many of our customers are really in need of a higher quality of support that really only Sun can give them in the Sun/Oracle combination and they are really looking to support, that is both hardware and software integrated more and more. So we are really moving ahead both technically and operationally to be able to deliver a more integrated support model for them. We do expect that customers will be, are very happy to purchase their support directly from Sun and not from others simply because the level of support and engineering support they need really can best, if not only be done by us at Oracle. We expect that to be very significant financially ultimately and that should start in the quarter.

Let me add one thing to that. As Safra said our buckets and processes are now in place. I think one of the more important ones that is in place is we look at margin on every transaction and if the margin is not attractive or worse yet negative which is often the case, by the way, in some of the bids we had in flight for high performance computing centers that we chose not to bid those. We said early on we would not engage in transactions where we lost money. We got out of businesses where we lose money. Again we look at it transaction by transaction. We do look at the long-term and how important is the customer. We might lose a little bit of money on the first sale but some of these huge high performance computing transactions add to our revenue but detract from our profits and we have a process now that identifies those and we walk away from them.

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

I want to make sure my math is right here. You said that the Oracle only software license grew about 10% constant currency and it sounds like you had about 5% foreign exchange benefit so you get about 5% constant currency growth from the Oracle only software license. That was versus the minus 8 to plus 2. I just want to make sure I got that right. Is that correct?

It is 10% as reported so you need to take away I think it was five points of currency and license so it would be five points of constant currency.

On the guidance you said that in [extremes] the lower close rates than you typically see in the fourth quarter. I am curious were the close rates you experienced in the third quarter lower than you typically see? We were hearing sort of mixed messages out there about the macro economy. It still doesn’t seem like it is very easy out there but curious what kind of close rates did you see in the third quarter?

Actually in Q3 we were really flat to last year’s close rates. We actually are seeing some pretty optimistic customers. Our pipeline is very big and the close rates I am using really are conservative and they are particularly conservative because as you know Q4 at Oracle is always a very big quarter and because the reps are all motivated to close as much as they can for their comp plan. So I just thought we might as well go with a reasonably conservative close rate but a potentially realistic one. We are actually quite optimistic about our customer’s appetites for our products. I am not going to comment on the whole economy. I don’t know the whole economy but we do find a lot of enthusiasm with our customers and deals do look like they are very good size in general.

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

Thanks for splitting out the revenue impact. I know you didn’t give the exact cost breakout but could you give us some sense of whether to cost of Sun ended up ahead of revenue just to give us a view of how to think about the full quarter that is coming up when we will see Sun from both a revenue and a cost perspective?

Actually the reason we didn’t give you a breakout is we really merged these companies fast. We just closed those and any kind of breakout would be really an allocation of a lot of different things. I will tell you the best way for you to judge what is going to happen is both to use our guidance and also to really look at what Q4 was. This Q3 if you think about it, it was February. By the time everybody knew where the water fountain was it was half way through February. So there is no way to extrapolate from this Q3 anywhere. Breaking it out is really not possible. You know us. We start integrating right away. Everybody is an Oracle employee as much as possible. Obviously selling hardware has lower gross margins than selling software regardless. There is no way to compare it. Our expenses are not a big number in comparison to our revenues so operating margins at least for awhile will be lower and you can figure that out from the guidance. Expenses grow quickly. But our revenues are growing quickly also and we will be able to really better extrapolate after you see Q4 frankly.

If I could ask a more product related question around Exadata, the goal there is it to replace kind of current data warehousing implementation or how do you go beyond the big data warehousing implementation into kind of a more broad deployment in someone’s IT environment?

Stage I or version one of Exadata was really aimed at teradata and [inaudible] and really the specialist data companies that focused on building custom hardware designed to tackle large scale data warehouse. That was Exadata version one. Exadata version two handles not only data warehouses but also handles transaction processing. We added a lot of Flash memory into it and we are going to have new Exadata models. I don’t want to preannounce anything. We are going to get better and better at very large scale transaction processing. Our intent is that the Exadata line challenge the biggest IBM P-series machines and beat them badly in performance, reliability and cost. We think we can do that in transaction processing we are twice as fast and in data warehousing we are ten times as fast. So twice as fast as IBM’s biggest, best box and again at a dramatically lower price. The answer is all database applications ultimately are best served when they run on an Exadata machine. Everything.

The next question comes from the line of Bill Winslow – Credit Suisse. Bill Winslow – Credit Suisse : You all reported pretty impressive return to growth in the application license revenue line. I am wondering if you could give us more of a sense of what you believe is driving that? Is it the core ERP, CRM, HCN applications? What are we seeing at apps? Is there anything across geographies you see different in the app space?

I am going to answer and then let Charles add to that. One is I think our vertical strategy is working extremely well. We are winning large deals in retail, large deals in banking and large deals in telecommunications. That is driving a lot of ERP and CRM applications with them. We are doing well in pharma. There are bunch of industries. Healthcare in general. There are a bunch of industries where we are very, very strong and we have applications that SAP simply does not have. One of our strategies was to beat SAP in CRM which we do and then beat SAP in industry specific vertical applications. For example, a telecommunications company has applications where you call up AT&T and you turn on your iPhone and you want to turn on interactive TV. Well that is provisioning software. When you provision an application in a lot of telco’s, when you provision an applications that is the Oracle software that is compartmentally turning on those services for you. SAP has nothing like that. When you receive your bill that is an Oracle application that is sending you the bill. SAP has nothing like that. When you deposit money in your savings account that is an Oracle banking application that keeps track. SAP doesn’t have that. I can go on and on in a variety of industries where we have industry functionality that they don’t have. That gives us opportunities that are simply not available to them. We also sell these applications a piece at a time rather than a big rip and replace strategy. So when people aren’t doing big ERP buys or by the way ERP is a rather mature market. We think we are competing very well in ERP. It is a mature market and SAP is…

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

I just have a question in terms of you shrinking the Sun footprint which you have spent some time discussing in the prepared remarks. I am trying to get a sense for have we seen the biggest rationalization of the product line at this point or are you going to see further partnerships like the Hitachi deal that still hasn’t kind of worked their way out of the rest yet? I guess I am trying to get a sense for the pace of the business going forward.

First of all I want to make sure you understand that the Sun product line continues in its current form. There is no cutting back on the Sun product line beyond where we are at. Those products are actually expanding. We have some incredible products coming up. The focus of Oracle and the Oracle/Sun combination is on reselling our intellectual property. So if you understand that then you realize in most places, there are certain areas in which obviously we have components from third parties in our equipment and all that but the real value is in our intellectual property and the way we bring it all together, etc. That is the focus of the company. We do resell some other folks’ products. We are still winding down the resale of the Hitachi storage servers. Obviously we are very focused on our customers and for those there will be a very steady wind down period. We are managing those together with Hitachi who has been a very long partner of Oracle and Sun and things are going very well there. The big focus of selling other people’s storage servers, that focus is really going to be going onto some of our own products that we talked about already. That is already in place. There are a few other reselling of other people’s software and things like that and as you know that is not what we focus on here at Oracle. So most of it is already disappearing outside of our sales. Again, don’t extrapolate anything from the month of February. Really, we will start to look at this more carefully and really spend some time to get a sense of what our business looks like after Q4.

Let me add just a little bit to that. We didn’t add much value selling Hitachi systems and we added no value making them money. So Hitachi is a fine product and Hitachi should sell it. Anyone who wants to sell it should sell it. Not us. We don’t make any money selling that. What do we make money selling? Our own storage. We have the NFS supplies ultimately the Sun 7000. We have our own storage server. Sun used to resell Veritas backup. Terrific product. We make them money reselling that product but we add no value so we are out of that business. The Sun businesses however we are expanding. We are expanding on the 7000. We are expanding on high performance, high end servers. Sun we are expanding and investing in Solaris and Java. The Sun IP and the Sun products we are expanding in. Where Sun was specifically a distributor of someone else’s intellectual property and lost money doing it we are out of that business.

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

On the Sun channel transition from indirect to direct, how are you managing through the transition? Secondly, how is Fusion turning back in terms of code readiness, data customer feedback and what is going to be the actual breadth of the product? Is it going to be all the products under the current umbrella or is it going to be a subset?

I will let Charles answer the direct and indirect question or Safra. Let me first answer how does Fusion look. One thing we did not do, we did not make the mistake of trying to get this thing out early. Were we late with Fusion? Yes, we were late. I would much rather be late than deliver a product that isn’t extremely high quality. Customers have been looking at Fusion. We have a number of large customers lined up to take the product this calendar year. We are again, we have put years and years of effort we have put into writing all of this in Java. Modern architecture. Modern orchestration. I could go on and on. This is 21st century technology. It is really the only application suite. Even SalesForce.com was a late 20th century technology. We think we are going to have huge competitive advantage. Customers like it very much because of the fact it can [inaudible] so they can start to use things to link the different web services together. It isn’t a rip and replace strategy. They can take parts of it at a time and gradually adopt Fusion. It has a modern web 2.0 user interface. It is low cost to deploy because everything is written…it is one technology stack. Java technology stack on our Fusion Middleware. The customers that have seen it see huge value in the built in business intelligence to VI is not an add on to Fusion. VI is built into Fusion. The application you install at your site is the same as the application you run on a cloud; our cloud or someone else’s. So it has generated a huge amount of enthusiasm. Customers are preparing their own adoption strategies, plans and schedules. It is all going to happen the second half of this year. Charles on the direct versus indirect?

In the Oracle business pre-Sun we ran about 40% and that fluctuates very little quarter to quarter. It has been pretty consistent for a long time. Sun was definitely higher than that. They ran about 65%. We will be shifting that to more direct strategy especially among the largest customers. We think they want and deserve direct relationship with Oracle. That is the best way we can provide the level of service we are anticipating. So incrementally starting this quarter we will be more direct. We want the partners to find new business and not show up in the same accounts all the time. So they get sales calls as we call them and shift away from fulfillment and expand the market. So we are going to direct them into the market and into areas where we don’t have good coverage. We are hiring pretty aggressively right now on the high end to make sure we have top 1,000 accounts serviced directly by Oracle reps and by Oracle support and we are also shifting the comp model to pay on a net, in other words Sun paid on gross. So the reps were indifferent whether a partner sold it or we sold it. We have always paid on net, in other words what we get after we pay the partner. That tends to shift things pretty quickly. The partners know that. The reps know that. We have discussed this with them. They know the strategy and so that will start to happen this quarter.

The next question comes from the line of Brent Thill – UBS. Brent Thill – UBS : The Americas business did a great job outpacing Europe. Can you give us a sense in terms of what you are looking at for a recovery in Europe in the second half? Do you expect this to be slower or snap back at a similar pace we saw in the Americas?

Europe tends to be more slow both in the downturn and the recovery. So they held up a little longer. You will recall that business there even with the U.S. was turning down we kept clicking along in Europe for 2-3 more quarters. So it does tend to take more time and more decentralized and a little slower but the pipelines are growing there so we expect gradual improvement in EMEA as well. Brent Thill – UBS : You mentioned ULA a number of times. I am curious if you see the environment stabilizing or are you seeing more customers coming back to ULA? If you could tie that into the apps business. Are you starting to see some of these broader deployments rather than just kind of piece mail decisions that are being made in division? Is that perhaps driving the better than expected growth in apps?

That is helping. We are also seeing ULA’s across multiple product categories. That includes Middleware and apps on the same deal. We have learned how to structure those. The other area is in Europe where uptake on ULA’s wasn’t as quick again because it is so decentralized. We are starting to see them get their act together and see the benefits of doing it all on one contract. So the ULA’s are picking up internationally as well.

With that we will conclude the question and answer session. I will turn things back over to management.

Thank you operator. 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 April 1. It can be found on our website at www.oracle.com/investor. 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 on today’s conference call. With that I will turn the call back to the operator for closing.

Thank you very much. Once again ladies and gentlemen that will conclude today’s call. Thank you very much for joining us. Have a good day.