Oracle Corp (ORCL) — Q3 2017 Earnings Call Transcript

Thank you, Holly. Good afternoon, everyone, and welcome to Oracle's third quarter fiscal year 2017 earnings conference call. A copy of the press release and financial tables, which include a GAAP to non-GAAP reconciliation and other supplemental financial information can be viewed and downloaded from our Investor Relations website. On the call today are Chairman and Chief Technology Officer, Larry Ellison; and CEOs, Safra Catz and 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 these forward-looking statements. And these forward-looking statements are also subject to risks and uncertainties that may cause actual results to differ materially from statements being 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 to these forward-looking statements in light of new information or future events. Before taking questions, we'll begin with a few prepared remarks. With that, I'd like to turn the call over to Safra.

Thanks, Ken. Good afternoon, everyone. I'm going to focus on our non-GAAP results for Q3; I'll then review guidance for Q4 and then I'll turn the call over to Mark and then Larry. Just so you all know, we're not all in the same place today, so we may all answer at once, so give us a chance. Clearly, we are delighted with our results as software and cloud revenue was at the high end of my guidance and earnings per share was $0.06, above the high end of my guidance. Our pivot to the cloud is now clearly in full strength. We continue to see outside growth rates in our cloud business, especially when compared with our key competitors who are all seeing slowing growth. But more importantly, the increase in revenue from our cloud business has overtaken the new software license business decline on an annual basis. Next year I expect our cloud revenue will be larger than our new software license revenue. The investments we've made to transition our business to the cloud have been important to ensure that Oracle remains a technology leader, and we're now beginning to see the benefits in our results. With cloud overtaking new software license revenue, we expect our business to once again exhibit the same pattern we delivered over the previous decade as a license business that is growing revenue with disciplined cost management that results in EPS and cash flow that grow even faster. I expect EPS growth to ramp up throughout next year. We continue to use constant dollar rates on our quarterly calls so we can have some measure of consistency across the quarters, as well as to reflect how we measure the business. This quarter, the effects of currency movement were largely in line with my guidance of a 1% currency headwind for revenue, with a $0.01 negative impact to EPS. Cloud, SaaS, and PaaS revenues for the quarter were $1.1 billion, up 86% from last year. You can also see the continued strength of our cloud business in the SaaS and PaaS billings and deferred revenue. The gross deferred revenue balance is now over $2 billion, up 75% in U.S. dollars; and SaaS and PaaS billings grew 111% in U.S. dollars this quarter. We've put the billings numbers up on our website for you to see the detail. When you add together cloud, SaaS, PaaS revenues, and new software license revenue together, we grew 11% in constant currency. This is a significant milestone in our transformation, where the combination of our cloud and new software license businesses added together are growing. As cloud becomes an even larger percentage of the total, the growth will only accelerate with earnings and cash flow following along. As our SaaS and PaaS business continues to scale and grow dramatically, the gross margin continues to expand. The Q3 gross margin for SaaS and PaaS was 65%, up from 51% last year, and I expect it to be about the same range in Q4. I expect that our total SaaS and PaaS gross margin will continue to trend toward 80% over time. Cloud infrastructure as a service revenue was $178 million, up 19% from last year. The Q3 gross margin was 30%, as we continue to make the necessary investments to scale out this business. As we make additional investments, the expenses are immediate while the revenues are recognized over time, so the gross margin in this part of the business could decline to roughly about 20% over the next few quarters. After which, I expect gross margin will climb to more than 40% as the business scales. Total cloud revenue in the quarter was approximately $1.3 billion, with growth modestly accelerating to 72% in constant currency from last year. Total on-premise software revenues were $6.2 billion with software updates and product support revenues at $4.8 billion, up 3% from last year. Attach and renewal rates remained at their usual high levels, as our installed base of customers continues to grow; in fact, it actually increased. New software license revenues were nearly $1.4 billion, down 15%, reflecting the continued emphasis on and migration to cloud. Total hardware, including hardware support, was down 9% with hardware systems product revenue of $520 million and hardware support revenue of $508 million, again reflecting our focus on the move to the cloud. For the company, total revenue for the quarter was $9.3 billion, up 4% from last year. Non-GAAP operating income was $3.9 billion, up 4% from last year, and the operating margin was 43%, up from 42% last year. The non-GAAP tax rate for the quarter was 21.6%, as the rate was favorably impacted by some one-time benefits and some other factors, including favorable geographic mix this quarter. Non-GAAP earnings per share was $0.69 in USD, up from $0.64, and up 8% in constant currency. The GAAP tax rate was 17% and the GAAP EPS was $0.53 in USD, up from $0.50 last year. Operating cash flow over the last four quarters was $13.5 billion, which is lower due to the rapid growth we're seeing as we transition to cloud, impacting our working capital. Our operational metrics like DSO and Days Payable are stable, so it's largely an effective growth on working capital and timing. Capital expenditures for Q3 were $440 million with about a third of it from real estate, while most of the rest was for cloud build-out and internal use. Free cash flow over the last four quarters was $11.8 billion. We now have approximately $69 billion in cash and marketable securities. Net of debt, our cash position is approximately $5 billion. The short-term deferred revenue balance is $7.4 billion, up 7% in constant currency. This quarter, we purchased approximately 30 million shares for a total of $500 million. Over the last 12 months, we've repurchased 124 million shares for a total of $5 billion and paid out dividends of $2.5 billion. The Board of Directors increased the quarterly dividend 27% from $0.15 to $0.19 per share. Now let me go to the guidance. Because we expect to see continued volatility in exchange rates, we do also expect to see significant currency headwind. I am going to give you constant currency guidance, but if the current exchange rates remain the same throughout the quarter as they are right now, we actually expect to see currency headwind of 2% on revenue and a $0.02 negative impact on EPS. These currency headwinds are higher than last quarter, meaning that most of your Q4 estimates do not yet reflect the incremental revenue and EPS headwinds of an additional negative impact of 1% and $0.01 to EPS. All of my guidance today is on a non-GAAP basis. With that, my guidance is as follows. SaaS and PaaS revenue, including NetSuite, is expected to grow 69% to 73%, effectively raising my full year guidance from 80% to 81% for the year. We're beginning to see an increasing and favorable attach between our PaaS and IaaS orders, so I'm going to provide guidance on IaaS as well this quarter. IaaS is expected to grow 25% to 29%. Software and cloud revenue, including SaaS, PaaS, IaaS, new software licenses, and software support is expected to grow 1% to 3%. Total revenue is expected to grow from negative 1% to positive 2%. EPS is expected to be between $0.78 and $0.82 in constant currency. Now, this assumes a non-GAAP tax rate of 23.5%, but of course the Q4 tax rate could end up being different. With that, I'm going to turn this over to Mark and then Larry follows him.

Alright, thanks Safra. We thought Q3 would be strong going in and as you can see it turned out to be just that. I'm going to give you a bunch of numbers here and try to give you a little bit more insight into the quarter. First, in ARR, we booked $545 million in USD. Every number I'm going to give you was actually in constant dollars, so to say it differently, $545 million in USD, $547 million in constant dollars, that is up 73% and the second best quarter we've ever had. SaaS bookings were $322 million in USD and PaaS infrastructure bookings were $223 million in USD. Cloud revenue was up 72% and we're now in an annualized $5 billion run rate. SaaS, PaaS revenue was up 86%. We're the fastest growing scaled cloud business in the world, and that growth rate is on top of last year's 60%. In ERP, we were up 280% organically, and with NetSuite, ERP is now our largest pillar. Fusion HCM was up 106%, which is more than three times the growth rate of Workday. CX was up 16% with marketing and service both over $100 million in quarterly revenue. Our verticals were up for 109% and also over $100 million in quarterly revenue. Database as a Service was up 427%. Our database business, including all of our on-premise businesses, net revenue. PaaS was up 375% year-to-date with cloud services up 300%. As Safra mentioned, SaaS, PaaS billings were up 111% in USD, and SaaS, PaaS deferred revenue was up 75% in USD. Now, some customer metrics: 1,125 new SaaS customers in the quarter, 908 expansions, and 210 customers who bought SaaS also bought PaaS. In CX, we had 480 new customers and 586 expansions. In HCM, we had 206 new customers and 217 expansions. In ERP, we had 564 new customers that did not include NetSuite; we got 120 expansions. 50% of our new ERP customers never had Oracle ERP before they bought this quarter. Our active base of ERP customers is now approaching 3,700, with 1,465 live, 10 times Workday. In total, we now have 13,103 customers in our SaaS active base and 25,000 with NetSuite. Two-thirds of our new customer wins were for Fusion, with 243 Go-Lives for Fusion and 2,444 customers now live on Fusion. We have 2,380 PaaS customers in the quarter and 2,586 new customers buying standalone infrastructure as a service. As a point of clarity, PaaS and infrastructure customers accounted for each service that they buy. Lastly, this was an excellent quarter. Bookings, billings, and revenue were all extremely solid. Now, a few predictions, Q3 bookings growth was strong, as I mentioned 73%. We will book at least $2 billion in ARR this year. Q3 revenue growth was impressive at 72% and with revenue now at an annualized run rate of $5 billion; we're clearly the fastest growing cloud company at scale. With that, I'll turn it over to Larry.

Thank you, Mark. Let's say Generation Two of Oracle's infrastructure as a service cloud now has the ability to run customers' largest databases, something that is impossible to do using Amazon Web Services. Amazon can only run relatively small Oracle databases in their cloud. Generation Two of Oracle IaaS also delivers ultra-high database performance and reliable functionality in the cloud. Many Oracle workloads now run ten times faster in the Oracle cloud versus the Amazon cloud. It also costs less to run Oracle workloads in the Oracle cloud than in the Amazon cloud. As a result, some of our largest customers are negotiating huge infrastructure as a service contracts to move all their databases to the Oracle cloud. You can expect some of those big deals to be announced in the coming weeks. Fast growth in the infrastructure as a service business is new for us. We've done well on SaaS and in PaaS over the past few years, but this is the first time we've ever had a technology lead in infrastructure as a service. We're now in a position to help our hundreds of thousands of database customers move millions of Oracle databases to our infrastructure as a service cloud. SaaS and PaaS are large, rapidly growing businesses for us. Together, SaaS and PaaS grew 85% this past quarter. But soon infrastructure as a service will be growing even faster and before long, infrastructure as a service will become Oracle's largest cloud business. In summary, all of Oracle's cloud businesses are growing rapidly and IaaS will be leading the way in the future. Thanks.

Thank you, Larry. Holly, if we could prepare the audience for the Q&A portion of the call now.

Thanks very much and congrats on a very nice third quarter. My question is for Mark. Mark, obviously a really nice quarter across the board, but particularly from a cloud bookings perspective, can you talk about what changed, if anything, in the quarter versus the second quarter, either in terms of the macro backdrop or better execution and just relatedly, we'll be interested in what you're seeing in the pipeline that gives you further confidence in that $2 billion ARR target. Thanks.

Kirk, I felt good about Q1, I felt good about Q2, I feel good about Q3; I didn't feel any major change. It's just really the timing of wins and bookings closed. We had a very strong set of quality wins. I mean if you win into HCM, just to give you some ideas, Kirk, we closed America Movil in the quarter, Cedars-Sinai Medical Center, Ford, Emerson, Hilton, Hyundai Motor, Jefferies, Rogers Communications, I mean we had a very strong set of logos in the quarter. I mean in ERP, we closed ClubCorp, Cummins, Lufthansa, Dish Network, I could go on. I don't have time to tell you all of these deals. But we saw it going in, we felt it would happen, it did, and I think our team executed well. I would say, Kirk, that there was no major geographic concentration, it was pillar centered. As I mentioned earlier, we had credible growth in ERP at 280% organically, we had a 106% growth in HCM, and we had strong growth in our sales automation business. It was broad-based, cross-pillar, cross-geography. Going forward, our pipeline is big. I mean I said before, I'll say it again, our pipeline's growth year-over-year resembles all the growth rates you've heard in terms of our bookings growth this quarter. And I think our execution just continues to get better. I'll also add in the quarter that NetSuite's performance accelerated, so compared to the last reported quarter in terms of bookings growth, their growth in the quarter, which for them was an odd thing because they're not used to having December, January, February quarter, but when compared it apples-to-apples, they grew faster than the last reported quarter in terms of bookings as well, so it's a very good quarter for us.

Hi, thank you very much. Mark, you must be wearing a suit and Larry, maybe you're wearing a sweater because you're talking tech and Mark is talking applications, so I'm going to direct my applications question to Mark if you don't mind. Mark, can you talk about what's ahead for cloud SaaS? Obviously, there are manufacturing, order entry, supply chain, those kinds of things that could book to the cloud. How should we think about the cycle ahead in that regard? Thank you very much.

It's a big change for us in ERP. This is not the world of two providers, and I was talking about upgrade cycles. What happened to us in ERP is, and I go back to the fact that 50% of our customers in the quarter were just brand new, so they never had bought ERP from us before. What happened is our total available market has just become incredibly large. If you looked at the persona of our customers that are in the ERP cloud today, most of them—more than 50% today—were not Oracle ERP customers before buying from us. So, I don't think, Kash, it's really more of a cycle. I think it's more of just an inflection point for us in terms of we're now at a place where we have almost 4,000 customers in ERP SaaS. Many of our on-prem customers have not moved, and yet we're in a position where we can go get a whole set of customers that we never had access to before. Mid-market customers, we can do that globally and we can go for customers that want to move to a SaaS application in the cloud and get all of those benefits. Frankly, our competitors' user bases have all opened up to us. And so, I don't see it quite as a cycle; I see it as a big change in the opportunity for us in terms of the total available market we can go after. Larry may have a comment or two he'd like to add as well.

No, again, I couldn't agree with Mark more. Our ability now to service much smaller customers than we could have serviced in the past is because the cloud allows you to deploy ERP at much, much lower costs. You don't have to have all the infrastructure built. Obviously, you don't need to hire programmers or a bunch of data operations people. We do all that for you, and therefore the available market has at least doubled what it used to be. And we're also beginning to see, as Mark said, SAP customers moving their ERP, and some very large SAP customers are looking very closely at our ERP systems. So, we expect to have some big wins in the SAP install base, and we're definitely going out further in the coming months.

Hey, thank you and congrats from me as well. I had a question around 12C. So, you have 12C now in the cloud for a good few months and I saw last week that it's now available on-premise. Can you talk a little bit about the early feedback from customers you saw and released to in the cloud and what does it mean now that it's available on-premise? Obviously, in the olden days that kind of spiked a little bit of an uptick in the database license growth; I'm just wondering how we have to think about it now in the new cloud world. Thank you.

I'll give you one important note: our cloud business is growing, and our license business per database is growing. So, our on-prem database business continues to grow. I'm not talking about the broader industry, I'm talking about new licenses. That business is growing and increased during this past Q3. A lot of our customers are planning to move their database workloads to our cloud, but they're going to bring their own licenses. In other words, they own a bunch of Oracle licenses, and they're just going to move those licenses to our infrastructure as a service. So, we expect our database license business to continue to grow. That should continue to respond kind of as it had in the past. In other words, the cool new features become available faster in-memory processing, the ability to take an existing single-tenant application and automatically turn it into a multi-tenant application, will be very attractive to our customers and our ISVs. They will buy more licenses, and they may then in turn bring those licenses to the cloud. So, we expect our on-premise or better said, our database license business to continue to grow and accelerate because of 12.

Just as a follow-up, because I know what Larry meant, our database business grew in the quarter. Support plus license plus database as a service—those three categories together—our database business grew in the quarter.

Hey, thanks guys, and congrats on a great quarter. I really wanted to focus on, in particular, on the PaaS line, because obviously you guys put up a huge ARR quarter there. Safra, you mentioned increasing the PaaS sort of IaaS to PaaS, part of our thesis has been, since you rolled out the new Datacenter 2.0 model on IaaS, that increasing attach there would then drive acceleration in the PaaS business. So, the question to, I guess, all three of you, and I'll jump off, is what are you seeing since the announcement of you had around OpenWorld on the IaaS side, and how is that impacting? How do you expect it to impact the PaaS business?

There are a lot of questions you had in one question there. So, I mean, I think the point we've continued to try to indicate is that we've seen a continual connection between PaaS and SaaS. So, we've got a bunch of SaaS customers who typically buy an application, and now we're starting to see that we have around 20% to 25% connectivity. When somebody buys the SaaS application, they also buy PaaS. I think part of what we're discussing with attach to the infrastructure is it becomes a bit harder to differentiate in some cases what is a pure infrastructure and what is PaaS, because the customer now buys the computing, buys the storage, etc., along with PaaS. So, you begin to get an upward integration of the infrastructure business and the database business, but there’s no question that we continue to see the attach rates continue to incline from PaaS to our SaaS business, which is at the core of your first question, Phil.

Yes. For our database customers, when they come in, they can order PaaS. They can also bring their licenses, use IaaS, and as a general matter, when they are running a database where they have something else too, they're going to need some IaaS to actually run their application when they're not our SaaS application. So, we're seeing these together very often. As we've now moved to our more advanced IaaS from what you used to have, I thought I would break it out for you to see it.

Operator: Our next question is going to come from the line of John DiFucci with Jefferies and Company.

Thank you. My question is for Safra. Safra, you've previously talked about double-digit constant currency earnings growth for next year. You had meaningful outperformance this quarter, and your guide was better than where the street is. I guess you also mentioned in your prepared remarks about EPS ramping through next year. I guess just to clarify, do you expect to still achieve double-digit growth? And is that exiting the year, will it be double-digit growth, or are you talking about for the entire year?

I expect that when you look at the entire year, it will be double-digit growth, but it will start smaller and get bigger as we progress through the year. In Q1, I don't know right now; it's a little too early. We'll talk again as to what I'm going to see. Things look nice, but I'm going to— we'll talk again in June on Q1. And I think by the end of the year, the only question is which quarter would drive into double-digit. It’s a little too early to tell, but I expect to see it for the year.

Okay, great. And just if I could a quick follow-up on a related profitability note, the one thing in the results this quarter was cash flow actually declined from a year ago, I think, this quarter. You mentioned in your prepared remarks working capital and timing issues. Can you just provide a little more detail on what you mean by that?

Yeah. I mean, there's really nothing in it. It is pretty much just timing of when we paid stuff and things like that. I mean, we would be filing our Q, our plan is to file it on Friday. You can spend the weekend digging through it. We dug through it; there is nothing interesting going on whatsoever. We're growing and it's really just timing of different working capital impacting accounts, really nothing in particular.

Next question, please.

Thank you guys for taking my question and a nice quarter. A new one for Larry just to clarify sort of the positioning on infrastructure as a service, when we think about sort of the Generation 2 offering, is the positioning a platform for your customers to run workloads primarily, or is it just more of a general-purpose platform that you expect to go head-to-head with AWS and Azure for general-purpose type workloads?

It's absolutely a general-purpose workload because Oracle database is a backend. We have no idea what that application might be. It could be on our backing application; it could be our DNA, basically our matching application. There are millions or tens of millions of Oracle applications running. They're going to have to move the infrastructure as a service, and the backend will probably run all the databases in PaaS. But we have to have a completely generalized infrastructure as a service offering that we built, and we think we have performance and cost advantages with our new Generation 2 over both Amazon and Azure.

Great, thank you so much, and congratulations on the quarter. I would love Safra, if you could give us an early indication or any potential impact you expect on the business model from SaaS B and IaaS B initiating new revenue recognition policies. Whatever you are seeing or thinking there that we should be starting to think about would be helpful.

Sure, for us, it's no big deal, actually. It's really very much a non-event. I do hear one of our competitors talking all sorts of stuff about it. Maybe they're trying to talk about something else, but for us, it’s really nothing. Zero impact whatsoever on cash flows and no impact on what we disclosed to you or any of the things that these other companies are talking about. For us, it's really nothing.

Great, thank you so much for taking the question. Just one is actually for Larry. I was wondering if you could share with us, it does appear that the company is coming to an inflection point in regards to your transition to the cloud, and given the results from today and your commentary about Q4 and the earnings growth for next year, how long do you think this could run?

Well, we have a very, very large database business. We have hundreds of thousands of database customers, and we have millions and millions of applications that run on the Oracle database. Most of those databases and most of those customers will move most of their databases and most of these workloads to the cloud. We think our cloud will be—right now we have a huge technology lead over both Amazon and Azure with our new Generation 2 infrastructure as a service. We can deliver ultra-high performance. People have been buying these Exadata Database Machines and are getting used to running very large databases very, very fast, and we can deliver comparable ultra-high performance at very, very low cost in our cloud. We think the migration of several hundred thousand customers and several million databases to the Oracle cloud may take at least five years, but the rate of migration is going to accelerate over those years, giving us enormous growth rates over that period.

Thank you, everybody, and thank you, Holly. 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 for any follow-up questions from this call. We look forward to speaking with you. With that, Holly, I want to turn it back to you for closing.