Oracle Corporation ORCL
Q3 2013 Earnings Call Transcript
Transcript Call Date 03/20/2013

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 - IR: Thank you, Elizabeth. Good afternoon, everyone and welcome to Oracle's third quarter fiscal year 2013 earnings conference call. A copy of the press release and financial tables, which includes a GAAP to non-GAAP reconciliation and other financial information can be viewed and downloaded from our Investor Relations website.

On the call today are Chief Executive Officer, Larry Ellison; President and CFO, Safra Catz; and President, Mark Hurd.

As a reminder, today's discussion will include forward-looking statements including predictions, expectations, estimates, or other information that might be considered forward-looking. Throughout today's discussion we will present some important factors relating to our business, which may potentially affect those forward-looking statements. These forward-looking statements are also subject to risks and uncertainties that may cause actual results to differ materially from statements made today.

As a result, we caution you against placing undue reliance on these forward-looking statements and we encourage you to review our most recent reports including our 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.

Finally, we are not obligating ourselves to revise our results or publicly release any revisions of these forward-looking statements in light of new information or future events. Before turning to questions, we'll begin with a few prepared remarks.

With that, I'd like to turn the call over to Safra.

Safra A. Catz - President and CFO: Thanks Ken. I'm going to focus on our non-GAAP results for Q3. I'll then review the guidance for Q4 and turn the call over to Mark and Larry for their comments.

While our overall business remains very healthy and we saw excellent pipeline growth, we're not at all pleased with our revenue growth this quarter. Though it didn't help that our quarter ended on the same day as the sequester deadline, what we really saw is the lack of urgency we sometimes in the sales force as Q3 deals fall into Q4.

Since we've been adding literally thousands of new sales reps around the world, the problem was largely sales execution especially with the new reps as they ran out of runway in Q3. As expected, many of the pushed out deals have already closed.

Our product portfolio is as strong as it has ever been and we won more than our fair share of deals. Our discussions with customers continue to be elevated to the most strategic level. There is a lot of enthusiasm around our leadership in software, engineered systems, and our real world approach to mixed public-private cloud deployment.

Looking forward, we're encouraged by the tremendous pipeline growth, but clearly we have work to do in training new reps on managing the sales process and the importance of establishing a quarterly rhythm with their deals. As such, I'll be conservative in my Q4 guidance, even though Q4 is the quarter the sales force is, in fact, geared to.

Now to the numbers in Q3. Currency movements reduced new license revenue growth by 2% and total revenues by 1% and net income by 2% and earnings per share by approximately $0.01, and I will focus on constant currency growth rates unless I say otherwise.

This quarter new software license revenue was $2.3 billion, flat in constant currency, down 2% in U.S. dollars. Cloud revenue was $238 million. On a GAAP basis, in constant currency, the Americas were down 1%, APAC was up 1% and EMEA was up 1%. Software license update and product support revenues were $4.3 billion, up 8% from last year and were nearly half of total revenue. Support attach and renewal rates continue at their usual high levels, actually at the highest levels for Q3 in the last five years.

Hardware system products revenue was $671 million, and while engineered systems again showed excellent growth, we continue to work through a product transition with the high end SPARC server line. Clearly, our customers know the new products are coming out next week and has held off buying the older M. We expect that the launch next week of new M line will help that.

Total revenue for the quarter was $9 billion, flat in constant currency and down 1% in U.S. dollars. Operating expenses were flat in constant currency and our non-GAAP operating margin expanded to a Q3 record of 47%, up from 46% last year, even though we substantially increased headcount. As revenues grow and we continue to manage our business with discipline, we still believe that there remains a lot of leverage in our business model.

The non-GAAP tax rate for the quarter was 21% and the GAAP tax rate was 19%. Both were favorably affected in this quarter by the retroactive extension of the R&D tax credit, though we did take a $65 million write-down of our Venezuela cash balance as the bolivar's official rate changed. EPS for the quarter grew 5% in U.S. dollars to $0.65 on a non-GAAP basis and would have been approximately $0.01 higher, but for the negative impact of currency on revenues. GAAP EPS for the quarter was $0.52, up 6% in U.S. dollars; would have been $0.53, up 8% but for the impact of currency.

Operating cash flow increased to $13.7 billion over the last four quarters, up from $13.5 billion last year and free cash flow grew to $13 billion over the last four quarters; both are record results for Q3. We now have nearly $33.4 billion in cash and marketable securities, and as we said before, we remain committed to returning that value to our shareholders through technical innovation, acquisition, stock repurchases, dividends and the prudent use of debt.

In this quarter, we repurchased 61.5 million shares for a total of $2.1 billion in the quarter. So, over the last 12 months, we have repurchased nearly 350 million shares for a total value of $10.6 billion.

Now to the guidance. So, for Q4, new software license and cloud subscription revenue growth is expected to range from 1% to 11% in constant currency and in reported dollars. Hardware product revenue growth is expected to range from a negative 22% to negative 12% in constant dollars, negative 23% to negative 13% in reported dollars. As a result, total revenue growth on a GAAP and non-GAAP basis is expected to range from negative 1% to positive 4% in constant dollars and U.S. dollars.

Non-GAAP EPS is expected to be somewhere between $0.85 and $0.91 both U.S. dollars and in constant dollars, up from $0.82 last year and GAAP EPS is expected to be somewhere between $0.72 to $0.78 in both U.S. and constant dollar. I've gone ahead and assumed GAAP tax rate of 23% and a non-GAAP tax rate of 24% and of course it may end up being different.

Now with that I'll turn it over to Mark for his comments.

Mark Hurd - President: Thanks, Safra. I'll just make a couple of quick comments before I turn it over to Larry. We've added over 400,000 people to the Oracle sales force in the last 18 months. We significantly expanded our customer coverage. We've seen material growth in our pipeline, but Q3 conversion rates were below what we expected, while our actual win rate went up.

Moving to Engineered Systems, a record quarter for us with more than 800 units sold in Q3, that's the best unit quarter ever. We've now sold that 5,000 Engineered Systems to date and the first full quarter for Exadata X3, we sold over 400 systems. The pipe is up materially and conversion rates are up. The (indiscernible) systems in particular sold extremely well causing the ASP to be down slightly, but these entry level systems is just a beginning as we expect to grow our business with these customers over the long-term.

Better news, our Exadata has carried over to the other Engineered Systems, which were more than 800 Engineered Systems sold this quarter. Exalogic, Big Data Appliance, the Oracle Database Appliance, all three saw 30% sequential unit growth. We had another solid quarter in our Verticals, which have grown faster than sold for a license in all of the last four quarters. We had great growth in cloud, CRM and HCM. Wins at Travelocity, Walt Disney World, Kaiser Foundation, Office Depot, Match.com, Deutsche Bahn, CGI Group, Southwest Airlines, Dow Chemical, Union Bank, Renault, National Instruments and (indiscernible). It's a lot of names, it took me a long time to read it, but I wanted to give you a flavor for the quality of names and the quantity of wins we had in the quarter that's driving our annual recurring revenue up nicely.

In other hardware, as Safra mentioned, the T-Series continue to be our best performing server product, but the N-Series lagged, ZFS Storage saw double-digit growth for the quarter, which is the seventh straight quarter. We've been able to materially grow our sales force and our R&D while overall operating expenses were essentially flat from last year and I think that's a testimony to our expense management and discipline.

Safra mentioned software support, which grew 8% in CD renewals rates as he mentioned at a five-year high for Q3 and by the way, virtually no expense growth in our software support business as we recorded those results.

With that, I'll turn it over to Larry.

Lawrence J. Ellison - CEO: Thank you, Mark. Next week we'll start deliveries of our next generation of servers built using our new SPARC T5 microprocessor, the world's fastest microprocessor. Next week we'll publish 17 world record benchmarks, including a TPC benchmark showing that the SPARC T5 is the fastest processor in the world for database. And the SPEC J Enterprise benchmark showing the SPARC T5 is the fastest processor in the world for its job in middleware.

Our new T5 servers have up to eight processors and are more than twice as that as the T4 systems they replaced. Even more important, our new M5 server which has up to 2 processors and runs its Oracle database over 10 times faster than the similarly priced old M9000 server it replaces. With the delivery of the M5 server next week Oracle will finish upgrading every server in the SPARC product line dating from the time we acquired Sun.

Ken Bond - IR: Thank you, Larry. Operator, we're now ready for the questions, please.

Transcript Call Date 03/20/2013

Operator: John DiFucci, JPMorgan.

John DiFucci - JPMorgan: Mark and Safra, I'd like to address a high level question because I know I'm going to be asked this a lot tomorrow. The softness this quarter was surprisingly broad based across both software and hardware and it looks like across all regions. We appreciate your willingness to kind of look internally for the causes and answers here, but given the breadth of the relative weakness, it really begs the question whether something bigger is at work here. How much macro-forces have come into play here or even perhaps the sales approach or strategy versus the execution of that strategy? In fairness you're still relatively early in the sales count expansion, but at this point, are there any thoughts or perhaps looking at things a little differently?

Mark Hurd - President: I'll take it. No. I think we feel – again let me just go through what I think Safra said and I'll sort of elaborate a bit on that. We feel great about both our strategy and our product line. So point one and two, we have no doubt, no question about that whatsoever. Second, to your point, we have increased the sales force dramatically and we feel great about our coverage. That really shows up first in the pipeline performance that we got. Our pipeline is up significantly. We don't give you a number because frankly I don't want you to give me a comparison every quarter, with the pipe, but it is up materially. The issue for us is simply convergence. And while, listen, you can come up and anybody can come up with all kinds of factors, there's always something going on around the world at any given time, and for us, we feel good about our ability to execute through it. And in this case, as I said, it really was just the conversion rate against the context of a materially higher pipeline.

Safra A. Catz - President and CFO: Yes, so, on covering sort of one through three of the issues, we don't think at all it's the product, because the pipeline is fantastic and our win rates are excellent. So, we feel very, very good about that worldwide. As far as being the economy, there is no really new news on the economy. As I mentioned, it doesn't help if the sequester deadline is on the last day of our quarter. And so, that has a little bit of an impact here in North America, but not necessarily anywhere else. The economy has been as it is in Europe for a while. So, there is no real new news. Then finally, on sales execution, why we think that's it, is frankly because it's playing out exactly that way as deals kind of flop over right into Q4. And so, especially with the newest folks, they're really geared to their annual target and there (is) little less urgency about Q3. For you who have covered Oracle for so, so long and for some of us who've been here long time, it was very Q3 and now it's extremely Q4 around here. And that is something we're kind of used to, except when there are acquisitions sometimes, you don't see it as much because of the new companies that what they bring and they change the seasonality a bit. But ultimately, Q3 is very similar to Q2, and then Q4 is a big quarter. Everybody is into Q4 and it really feels like that around here right now.

Operator: Brent Thill, UBS.

Brent Thill - UBS: A question for Larry on the Hardware business. Q4 was set to be an inflection point and it appears that has been pushed out. But what's your sense on the turnaround, and if you could just contrast on the Exa side versus the other side of the Hardware business, maybe some more metrics to what you are seeing?

Lawrence J. Ellison - CEO: Sure. Well, the oldest product in our product line the M9000, the large scale M systems, which we hadn’t refreshed for several years, and we saw very, very substantial and continuous decline in that business. It wasn’t helped by people who were aware that we are going to go through a product transition in Q4. So that didn’t help us in Q3, and then now we have got to go through this product transition in Q4. We are announcing the new M5, a new T5, and we think people might take a couple of months to evaluate these systems before they verify that our claims are correct. The T5 is more than twice as fast as the T4 it replaces, much better price performance. Amazingly the M5 is more than 10 times faster than the M9000 that it's replacing. So we think Q4 will be better than Q3 as far as the Hardware is concerned. But I think we expect the turnaround really to begin in Q1, not in Q4, because we have this large introduction of new systems. I think the other thing that Mark alluded to was that we announced some lower end Exadata systems in our engineered specs, and people have been beginning – new customers are beginning with the smaller systems as opposed – now that they are available as opposed eight-rack to having quarter rack. That's somewhat lowered our ASP this past Q3. I think we work our way through that over the next two quarters, and again I think Q1, you're going to see a big turnaround and next year it will be a big growth year for our entire Hardware business. The spot line and all of the engineered systems.

Lawrence J. Ellison - CEO: Ben, I'd just add a couple of comments on the Engineered Systems line, so you have more clarity on the eight-rack. This is actually good news, even though it lowers ASP, because we delivered a lot more technology and a lot more performance. As I mentioned, our unit counts were the record level in Q3, and we have the opportunity to upgrade those machines over the long run. So, the fact that we've seen our pipeline is up, our unit levels are up, and so I think, to Larry's point, this puts us in a really strong position as we get into Q1 of next year on the Engineered Systems side as well.

Operator: Phil Winslow, Credit Suisse.

Philip Winslow - Credit Suisse: Just have a question on the software business. I know you guys don't break out database and middleware, tech versus applications anymore, but wondering if you could just give us a sense of what you saw this quarter in terms of the performance between these two old segments, and then just what you are seeing in the pipeline, and then also just one follow-up for Larry specifically to Oracle Fusion Applications. There has been some debate out there about what your win rates are with Oracle Fusion Apps versus some competitors, and if Oracle Fusion Applications, are they more modern, less modern than competitors? Just provide us an update on where we stand there, that would be great.

Safra A. Catz - President and CFO: Basically, database and apps moved together in the quarter. So, there is no special news there one way or the other. I think second question is for you.

Mark Hurd - President: It was actually over to Larry on the Fusion.

Lawrence J. Ellison - CEO: Yeah. I think one of the things we've done is we’ve become very, very focused on not just Fusion Applications, but all of our cloud applications. So, we really – a lot of the new headcount, a lot of the changes in organization, in the field have been based on focusing on the cloud; increasing our win rate in the cloud, having specialization around HCM, having specialization around service with our RightNow products, specialization around sales with our Fusion sales product as we go against our secular competitor, Workday and Salesforce.com and some of the others. So, I think in the third quarter we saw very good growth. We saw very, very good growth in the cloud. That was not the issue. It's just that our cloud – when I talk about the cloud, I'm talking very specifically about the SaaS portion of the cloud. We're in all aspects of the cloud. We're in infrastructure, we're in platform, and we're in SaaS. So, with the number of – when we give you $1 billion, that's $1 billion pure SaaS number. That's growing very, very nicely. The problem is, it still is relatively small business with a very, very high growth rate. We are focusing on that and we're getting very good result there against the competition. Our win rates are going up versus Q2, the growth is excellent, but we think we deployed a lot of resource on that to get those win rates and get that focus, but the business is still relatively small compared to our overall $40 billion business.

Operator: Heather Bellini, Goldman Sachs.

Heather Bellini - Goldman Sachs & Co.: This question is for Mark. Mark, you and Safra both highlighted sales execution as the reason for the shortfall this quarter, after posting a strong 2Q. I'm just wondering if you could give us a sense of how long do you think the transition looks like. Is it one quarter or two quarters? And as a follow-up, what does the ramp look like as execution improved?

Lawrence J. Ellison - CEO: I'll just say we expect it to be within the context of Q4. So, we saw many of the deals that we've described are closed. So, we expect it to be relatively quick. On the (bring up), and I think Heather what you mean is the ramp of the sales people that's turning into pipeline and turning into growth, and if it's not, I am sorry, but that's the question I'm going to answer…

Heather Bellini - Goldman Sachs & Co.: Yeah. No, that's perfect exactly.

Lawrence J. Ellison - CEO: All right. So, I think it really is just about the speed of getting our conversion continuing to climb. So, our pipeline is behaving – I wouldn’t say linear to the higher, but in the way you would expect it to. You would expect a timeframe for a new hire to come on board, get trained, get assimilated, get engaged with our management, and I would say the pipeline is behaving roughly as you would expect relative to the ramp of those sales resources. So, when you hear Safra and I talk about the pipeline, we measure it very closely and we see it there. So, it's just a question of how we convert, and I won't go into the role of predicting revenue growth rates out several quarters other than to tell you that we have a lot of coverage and we have a pipeline that's growing substantively. @@@

Operator: Kash Rangan, Merrill Lynch.

Kash Rangan - Bank of America Merrill Lynch: Looking forward to the magic of May quarter. But as it pertains to this quarter, Mark, I'm just curious when you ended up the November quarter, could there have been a chance that we softened business, meaning pulled in potentially as people, customers were somewhat leery of this fiscal cliff, all bunch exchange concerns that might have actually caused some deals to get done a little bit earlier than expected which obviously benefited your November quarter. I am just curious to see if you think that could be an attribution to what happened to February quarter, and also just wondering if you have any thoughts on how to think about the growth rate of engineered systems. I think you've characterized it as being 70%, 80%, maybe even potentially doubling. I just wanted to see how we're tracking towards that goal for this year?

Mark Hurd - President: I think the answer to your first question is sure. I mean there's potential of deals going that were in Q2 was better, some deals go to Q4. I think there's all kinds of things you get to. What we do know we've got a lot of deals in the pipeline and we're in good shape on those deals. And I mentioned, in the context – I think the better way to look at cash is that we don't just measure the pipe. There's two different ways to measure a pipe when it concludes. One is the conversion rate; meaning, the aggregate pipe and how it converts to orders. The second way to look at it is the win rate in the context of the deals that do get decided (indiscernible). Our win rate went up in the context of the conversion rate going down. So it's an important thing to measure because some of (it's are of activity) in the time the decision gets made. In engineered systems, unit count was great. As you heard Larry and I both mention, we had an ASP decline, not because unit count, but because of the average selling price in the movement to conversions or to (indiscernible) which actually brings the average selling price down. Unit count, I think we're roughly in line with the number that you described there.

Operator: Jason Maynard, Wells Fargo.

Jason Maynard - Wells Fargo: I want to tackle this maybe from a different angle. Can you maybe talk a little bit about what you're seeing in terms of customer adoption of Fusion? What are you seeing in terms of uptake, at least within the installed base, upgrades in number of go-lives? How is that trending across verticals and product lines and how does that bake into your equation for closure rates in the next couple of quarters and getting confidence with new customers to buy these whole broad suite of apps?

Lawrence J. Ellison - CEO: I mean, a great question, and it's interesting that – we monitor this very, very closely. In HCM alone, we have 30 customers going live in the next six weeks, and that's very, very important. And that's extremely important as our reference base increases. These are relatively new businesses for us. So, our reference base is greatly expanded in HCM. That' one of our main focus areas; like services, like sales. So, we're very – our win rates against Workday are going up. And Mark pointed out, we follow our secular competitors very closely. We look at every competitive deal. We measure our win rates. And those win rates against Workday are going up and we think we're – we actually have a new and improved UI coming out for all of our cloud applications. It's a change in our middleware platform. So it automatically – that UI suddenly appears in all of our cloud products. So we've improved the UI. So, we have lot more references coming on. The technology continues to advance. The UI is making giant step forward. So, we are encouraged their ability to compete and win in the marketplace. It's getting better every month.

Operator: Raimo Lenschow, Barclays.

Raimo Lenschow - Barclays Capital: I wanted to go – look a little bit beyond the quarter. What we saw this quarter is obviously in Q3 the announcement of the acquisition of Acme Packet. TO get you deeper into the telco plumbing can you talk a little bit about your motivation and strategy for this vertical?

Lawrence J. Ellison - CEO: I think what – we have a very, very significant presence in billing systems – in provisioning systems in the telco spec. What we like to become is a more or one of the most strategic suppliers in telcos overall which involves broadening our footprint of what we supply them. So you are going to see us through our own engineering, through innovation and acquisitions greatly broaden our footprint as our ambition is to be the primary technology provider to the telecommunications industry. So that's an area where we have been very successful in certain parts of it and we think we can expand that business by again adding to the footprint. You are going to see us adopt a similar strategy in retail and in financial services. A combination of innovation and acquisitions to broaden our footprint, to become more and more strategic to telecommunication companies; more and more strategic to retailers, more and more strategic to banks, as we can solve more of the problem.

Mark Hurd - President: I am really glad you asked that question when we announced the acquisition it was during our quiet period and most of the people that wrote about it wrote about it as a horizontal networking acquisition and what we were doing was exactly what Larry described, phone companies as two networks or two sets of IT systems, those that manage the business and those that manage the network. This was an opportunity for us to get into that network side of the business and if you will open up an entirely new opportunity for us strategically inside the phone companies and leverage our existing go-to-market, our existing assets and our existing relationships. So, we look at this just as a fantastic acquisition to build on our assets that exists already in CGBU if not communications particularly.

Operator: Brendan Barnicle, Pacific Crest Securities.

Brendan Barnicle - Pacific Crest Securities: Safra you mentioned that maintenance attach rates were at the best levels in Q3 that you've seen in five years? What do you think is driving that attach and what are you seeing in terms of pricing and competition around maintenance?

Safra A. Catz - President and CFO: Well, as a general matter really the only place to get the updates for your products in addition to the product support is from Oracle. So as a general matter, customers know that the value they're getting from the licenses that they bought often years ago is when they upgrade and when they get all the new features and there is quite a lot of interest in making sure folks are staying current, especially as they were looking at their datacenters et cetera and as a result, I think we just continue to offer them fantastic value and we are the place for them to get the updates that they need.

Mark Hurd - President: Operator?

Operator: Ladies and gentlemen, that is all the time we have for questions, I would like to turn to call back over to today's presenter for any additional or closing remarks.

Ken Bond - IR: Thank you, Elizabeth. A telephonic replay of this conference call will be available for 24 hours. Dial-in information can be found in the press release issued earlier today. Please call the Investor Relations department with any follow-up questions from this call. We look forward to speaking with you. Thank you for joining us and with that we'll close the call.

Operator: Once again that does conclude today's conference and we thank you for your participation.