Oracle Corp (ORCL) — Q4 2018 Earnings Call Transcript

Welcome to Oracle's Fourth Quarter 2018 Earnings Conference Call. Now I'd like to turn the call over to Ken Bond, Senior Vice President. Sir, you may begin. Thank you. Good afternoon, everyone, and welcome to Oracle's Fourth Quarter and Fiscal Year 2018 Earnings Conference Call. A copy of the press release and financial tables, which includes the 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. 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. And 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. And with that, I'd like to turn the call over to Safra.

Thanks, Ken. Good afternoon, everyone. We had a terrific quarter and a tremendous number of wins in the cloud, with total revenue growth 1 point above the high end of my guidance, and earnings per share $0.05 above the high end of my guidance. Before further discussing our Q4 results, I'd like to comment on updates we've made to our financial reporting, so as to better describe our business since we introduced the BYOL license initiative to our customers. BYOL, which is bring your own license, allows customers to move their existing on-premise licenses to the Oracle Cloud so long as they continue to pay support for those licenses. BYOL also makes it cost effective for customers to buy new licenses even if those licenses are only going to be used in the cloud. So some of our customers are buying new licenses and immediately deploying them in the cloud. In fact, our largest license sale in the quarter was a cloud license. Other customers, like AT&T in the release, are moving their existing licenses, excuse me, moving the existing licenses they own to the cloud, while continuing to pay support. Support for licenses that have been moved to the cloud is Cloud Support. As a result, our new License revenue is now a combination of new cloud licenses and new on-premise licenses. Our Support Revenue is now a combination of cloud license support revenue and on-premise license support revenue. To reflect these changes in our business, we have now labeled new software licenses as Cloud License and On-Premise License. And we've combined cloud SaaS plus cloud PaaS and IaaS plus software license updates and product support into Cloud Services and License Support. So to say it another way, customers are entering into large database contracts where some of those database licenses are to be deployed on-premise, while other database licenses are used in the cloud. Previously, all of those licenses and their related support revenue would have been counted entirely as On-Premise, which clearly, it isn't. In addition, customers that are in the process of moving their existing database licenses to the cloud previously had all of their support revenue counted as On-Premise, again, which it isn't. We have reflected these revenue reporting updates in our expense reporting as well. Our cloud, SaaS and PaaS and IaaS services are all moving into our new second generation data centers based on our bare metal infrastructure with a single unified operations team. Data center expenses there are shared across SaaS, PaaS and IaaS, giving us economies of scale and other efficiencies. We've also consolidated most support functions across our software technologies in the cloud and on-premise. Sharing our teams across the different offerings allows for improved asset utilization and has a positive effect on our gross and operating margin. Now that we have built a rapidly growing multibillion-dollar cloud business, our management team is focused on two principal financial measures to judge our success: First, we expect our overall revenue growth rate to accelerate because our growing cloud revenue is becoming a larger and larger percentage of our total revenue. While any one quarter's results may vary, we expect to increase our revenue growth rate this year and beyond. Second, we expect that we will once again deliver double-digit EPS growth for the year. Okay, turning back to our results. First, I'll go over Q4 and recap fiscal year 2018 before moving on to my guidance. I'll then turn the call over to Larry and Mark for their comments. As in prior quarters, I'll review our non-GAAP results using constant dollar growth rates, unless I say otherwise. This quarter, currency movements resulted in a 2% tailwind on revenue, which was approximately $140 million less than when guidance was given. And currency movements had a $0.02 positive impact on non-GAAP EPS, which was $0.01 less than the $0.03 which I guided to. Regardless, we've exceeded the high end of both ranges. Total Cloud Services and License Support revenues for the quarter were $6.8 billion, up 5% in constant currency, 7% in U.S. dollars. Under our prior reporting structure, in Q4, what we previously called Total Cloud revenues were $1.7 billion. I cannot stress enough the stability and growth of our installed base of customers quarter after quarter. Our customers are maintaining and expanding their Oracle environment because they have the portability to use our licensed software on-premise, in the cloud or via a hybrid environment. This is largely because our products are capable of doing things others just can't do, whether that's security, performance, scalability or the autonomous features that only our database has. As our customers adopt our technologies, whether via licenses or cloud services, our overall customer base is growing, and that growth is starting to accelerate. The gross margin for Cloud Services and License Support was 86%, and as we continue to scale and grow, I expect this will go even higher. Total revenues for the quarter were $11.3 billion, up 1% from last year. Non-GAAP operating income was $5.3 billion, up 4% from last year. And the operating margin was 47%, which was up from 46% last year. The non-GAAP tax rate for the quarter was at 19.2%, slightly below our base tax rate of 20%. And EPS was USD 0.99, up 11%, and up 9% in constant currency. The GAAP tax rate was 17.7% and GAAP EPS was USD 0.82, up 8%, and up 5% in constant currency. Now moving on to the full fiscal year. Total Cloud Services and License Support revenue was $26.3 billion, growing 7%. Total company revenues for the year grew 3% to $39.9 billion. Non-GAAP EPS was USD 3.12, up 11% in constant currency, and up 14% in USD. This was largely driven by the acceleration in operating income growth, which was up 9% in USD, and 6% in constant currency. This is mirrored in our operating margin for the full year, which was up from 43% last year to 44% this year. As a reminder, our best-ever full year operating margin was 47%, and I expect we will surpass that in the coming years as our total revenue growth accelerates and we benefit from greater scale in our business. Operating cash flow over the last four quarters was a record $15.4 billion, up 9% in USD. Capital expenditures for the year were $1.7 billion. And free cash flow over the last four quarters was $13.7 billion, up 13% in USD. We now have approximately $67.3 billion in cash and marketable securities. Net of debt, our cash position is approximately $6.6 billion. The short-term deferred revenue balance is $8.4 billion, up 2% in constant currency. As we've said before, we're committed to returning value to our shareholders through technical innovation, strategic acquisitions, stock repurchases, prudent use of debt and a dividend. This quarter, we repurchased 106 million shares for a total of $5 billion. Over the last 12 months, we have repurchased 238 million shares for a total of $11.5 billion. Since FY '11, when we ramped up the share purchase program, we have reduced the shares outstanding by more than 20%. In addition, we have paid out dividends of $3.1 billion over the last 12 months, and the Board of Directors again declared a quarterly dividend of $0.19 per share. Now to the guidance. First of all, we will be adopting the new accounting standard, ASC 606, with a full retrospective view starting in Q1. We will also provide you with the prior year results reflecting ASC 606 so that you can compare it. Secondly, my EPS guidance for both Q1 and FY '19 assumes a base tax rate of 20%. However, one-time tax events could cause actual tax rates for any given quarter to vary from our base rate, but I expect that in normalizing for these one-time events, our tax rate will average around 20% for fiscal year 2019. Importantly, in regard to Q1 guidance, exchange rates have moved from a 3% revenue tailwind to now being a 1% headwind from the last time I gave guidance. That is a 4% negative move, which impacts revenue in Q1 by about $300 million. It also impacts EPS negatively by $0.03. So for my guidance, total revenues are expected to grow 1% to 3% in constant currency. Non-GAAP EPS in USD is expected to grow between 9% and 13%. I'll do the math for you, that's between $0.67 and $0.69. And non-GAAP EPS in constant currency is expected to grow between 11% and 15%. And again, doing the math, that's $0.68 to $0.70. For the full year, we expect to have a higher revenue growth rate than FY '18 and to, once again, deliver double-digit non-GAAP EPS growth. Total CapEx for FY '19 is expected to be similar to FY '18's CapEx of $1.7 billion, but it could be a little higher, depending on bookings. With that, I'll turn it over to Mark for his comments.

Thanks, Safra. I wanted to start by highlighting some cloud wins in Q4. In the ERP sector, we had several notable clients such as BAE, Baylor University, Cerberus Capital Management, Con Ed, and many others. We see significant value in this quarter not just in the volume of wins but also in the quality of the companies. Moving on to HCM, I’d like to emphasize that every success was against Workday, with wins including Akamai, AT&T, and Baylor University, showcasing a dual ERP HCM victory. Additionally, we had impressive wins with City of Jacksonville, Delta Dental, and Toyota Motor among others. The momentum continued with two key ISVs going live in production with us, including Manhattan Industries, as well as a large networking ISV. We outperformed AWS in terms of price, performance, and service breadth for these deals. Regarding AT&T, they are transferring vast amounts of data to the Oracle cloud, and we expect to connect their data centers within the fiscal year. The apps ecosystem is now over $11 billion and has grown by 11% year-over-year, driven by a substantial number of recurring revenues. Overall, ERP and HCM revenue reached $2.2 billion annually, and we saw impressive growth in our Fusion applications. Notably, NetSuite bookings soared by 62% in constant currency, which reflects our strategic market investments. Our tech ecosystem has also expanded beyond $21 billion, showing robust growth. The new license revenue from our database offerings increased, with our next-generation PaaS revenue reaching $1.1 billion. In summary, we are successfully executing on our expanding pipeline in both applications and the autonomous database, aiming for higher revenue and double-digit EPS growth in FY '19. Now, I’ll hand it over to Larry.

Thank you, Mark. We've just about finished enabling all of our SaaS, PaaS and IaaS cloud services to run alongside each other in our new second-generation bare metal data centers. This consolidation of all three categories of cloud services, SaaS, PaaS and IaaS into a single standard data center, allows us to share assets while giving significant economies of scale. As a result, we expect continued expansion of our cloud margin. But just as important, to have SaaS, PaaS and IaaS in the same data center makes it easier for our Fusion customers to extend those SaaS applications using our latest PaaS and IaaS technologies and capabilities. As an example, we recently demonstrated how one of our customers used our mobile service, our cloud global service, our cloud voice service and our cloud machine learning service to extend our Fusion HCM system with an Amazon Alexa voice interface for vacation requests and vacation approval. We've developed these new technologies, machine learning, voice and mobile, so we could voice-enable all of our applications. And we're putting those voice systems, a combination of chatbots, voice, all machine learning-driven, we're putting those voice interfaces as the next generation of our UI for Fusion ERP and Fusion HCM. The technologies that we use to add voice interfaces to Fusion HCM and Fusion ERP are available as PaaS services in our cloud to our customers. So if there's something they want to add to Fusion ERP or HCM, they could do it using the same tools we use to build the applications in the first place. We think that's a big deal. We think having SaaS, PaaS and IaaS all integrated together in the same data center is a key differentiator between Oracle and our cloud competitors, most of whom are focused primarily on SaaS only or primarily on IaaS only. With that, I guess we'll open it up for questions.

Thank you, Larry. Operator, if you please prepare the audience for Q&A. Thank you.

Mark, I think it's fair to say everyone's very surprised by 9% database license growth in the quarter. I want to make sure I heard that right, and that overall database ecosystem growth accelerated in Q4, and this is even without the autonomous database fully available just yet. So my question, how much of this is just customers purchasing ahead and buying into the strategic roadmap? Or are there other factors we should consider?

First of all, I'm glad you got those numbers right because it confirms I communicated them correctly. We did notice an acceleration during the quarter, which I believe is due to a combination of factors. We have seen strong demand consistently across the board. I also highlighted the significance of the option number, which was in the mid-double digits this quarter, essential for enabling our autonomous database. This is a key metric because it reflects whether it's contributing to cloud revenue or license revenue, and we are seeing evidence in both. For instance, we had a notable win this quarter with Ford, which involved a combination of a licensing agreement and cloud engagement, aligning with our historic revenue reporting. As I mentioned earlier, we are just starting to see the impact of the autonomous database. We officially launched the autonomous database data warehouse at the start of Q4, so it's just now beginning to appear in our pipeline. The numbers from Q4 clearly indicate progress, and we are witnessing the technology rollout across numerous trials and proof of concepts, which are the initial stages of this process. We are quite optimistic about these developments and the positive Q4 results are encouraging as well.

My first question is for Larry. I want to understand better the customer demand and adoption trends related to what AT&T is rolling out. Additionally, I would like to hear about how regular annual database updates, compared to historically large and monolithic upgrades, might influence customers' software buying patterns and if that is something you're starting to observe or consider.

A few years ago, we could expect a major database release every 2.5 years, which often led to increased purchasing. While we still have significant database releases on a regular basis, the cloud enables us to release updates more frequently. Many autonomous features are now being introduced at a rapid pace. For instance, we launched our autonomous database at the start of Q4. Soon, we will introduce a simple autonomous transactional system that combines OLTP and data warehousing. Following that, we plan to release a high-performance OLTP system in a couple of months. The autonomous features are rolling out faster than some of the more established database features, especially those focused on the cloud, which are being delivered at a higher rate. I hope that clarifies your question.

Just a question to the team here. On the Q1 call, you talked about the legacy IaaS business versus the new IaaS business. And then, on the Q3 call, you talked about your legacy SaaS versus the newer SaaS products. And Mark, obviously, you gave some color on the newer ones in your prepared remarks. But hoping you'd just give us a little more detail, sort of just the trends that you're seeing there, call it new versus legacy IaaS and SaaS. And how are you thinking about sort of the criss-cross points there with the newer businesses that are growing quickly, sort of getting big enough and keeping growing fast enough to sort of offset whatever you're seeing on the legacy front?

Is it for me or for Mark?

I'm taller, so I'll start. You made a good point, Phil. Just to give you an example, I mentioned two wins: Manhattan and a new Independent Software Vendor, which I referred to as a big networking company. This is a completely new application on the Oracle cloud. Remember, this is a brand-new application for Oracle, as it wasn't previously running on our platform. We've successfully migrated it to Oracle as well as to the Oracle Cloud. There are a few different dynamics involved. Yes, there are some legacy elements and what you might consider traditional reporting that we use, but we're really just at the start of this journey. As Larry noted, we launched our autonomous database in April, and it's beginning to appear in trials and Proof of Concepts, though it's not reflected in the numbers you're seeing yet. We're securing new ISV partnerships that are entirely new to Oracle, alongside bringing in our existing customers. So we are still in the early stages, and there's significant potential for growth. The main focus for us has been getting our products into the market, particularly the next generation infrastructure that I mentioned, which is growing at a 45% rate. This is just the early phase of development, Phil. These new wins, including the trials and Proof of Concepts, along with the ISVs, have yet to significantly drive revenue because the work needs to be done before we can move to production. In fact, some of our partners have just begun to transition a few customers to the Oracle Cloud. We're at the very beginning of this process, and we anticipate seeing positive changes soon.

I wanted to ask a little bit about BYOL and Oracle Cloud infrastructure. And Mark and Larry, I know you guys touched on this a little bit in your prepared remarks, but can you give us a sense of where we are in the migration to BYOL? And I guess, in particular, can you give us a sense of the momentum within your enterprise accounts using these technology rights in the cloud? And how do you see the slope of this adoption curve as you look ahead?

I believe the most notable aspect of the quarter was our largest new license purchase deal, which involves a customer committed to deploying 100% of it in the cloud right away. We have mentioned AT&T several times as an example of a significant customer intending to migrate most of their Oracle data to the cloud. This represents a substantial shift, though AT&T is unique due to the size of their Oracle databases. Many of our other clients now have the option to bring their Oracle database licenses from on-premise to our cloud through BYOL, where they merely cover the additional infrastructure costs while continuing to pay support for what converts to a cloud license. This presents a highly appealing value proposition for our customers, and we are observing considerable interest among our largest clients in starting the migration process.

Can you provide more details about licenses? Last year's fourth quarter had strong performance in this area, making it a challenging comparison. I remember that in the last quarter, there were discussions about some delays in the vertical apps. Could you explain how we arrived at the current numbers, including the bring your own licenses, and how we might see upside potential?

We sold more, and it's a combination of the factors we discussed. Last year's Q4 was a strong quarter for us, making it a tough comparison. However, the quarter performed well across all areas. The only significant issue we faced was currency fluctuations; we anticipated a 3-point impact but only realized 2 points. Overall, it was a solid quarter, and I don't have many specific stories to enhance that. The database ecosystem showed strong growth, particularly with options related to the autonomous data warehouse. Our application licenses did decline as expected, but remained relatively stable, which was better than I anticipated. The quality of our bookings was also encouraging, and I want to highlight the performance of NetSuite bookings. While they met our expectations, it's gratifying to see how well our investment in that acquisition has paid off. It will reflect in revenue as we move into 2019. Overall, we also have significant leverage in our expense structure, making this a very solid quarter from an operational perspective. Perhaps that's more detail than you were seeking.

Well, also, Raimo, let me just add, we launched BYOL at the very end of Q2. And this really opened up a lot of EULAs and PULAs for our customers who are very interested in being able to deploy in the cloud and on-premise. It's of particular value to them. And so there are literally billions of dollars involved in these agreements. And many, many customers. It is very widespread and it really showed up in Q4. And it shows up in all the quarters, but of course, after BYOL, it really showed up in Q4.

Kirk, we can't hear you. Kirk, going once, twice. Operator, next question please.

I think it's probably a question for either Mark or for Larry. Can you talk a little bit about how customer demand for database in the cloud is evolving, both for new workloads and for existing workloads, and how the balance is working out by whether or not they're choosing BYOL or Database as a Service?

Well, during the early stages, it's primarily been about bringing your own license for new workloads and transitioning existing workloads. Oracle has the largest market share when it comes to databases, outpacing IBM and Microsoft combined. We have a vast array of significant databases, with immense amounts of information that our large customers want to manage with their own licenses. They prefer to shift gradually rather than all at once. For instance, AT&T has committed to a swift transition, while other customers are progressing at a slower pace. These customers are also acquiring additional options for their existing licenses to facilitate their move to the cloud and take advantage of autonomous services. To illustrate, if a customer wants to migrate 10% of their databases to the cloud and utilize the autonomous database, they need to have the multi-tenant and real application cluster options licensed. If they haven't previously licensed these options, they would enter into a large license agreement to add them, along with possibly securing additional database licenses. Once they obtain these options, they can access the autonomous database services. If a customer chooses not to utilize the autonomous features, they can still move their databases to our cloud, albeit without the autonomous benefits. Most customers, however, are enthusiastic about the autonomous features since they reduce labor costs and significantly enhance security and reliability by eliminating human error. This results in considerable savings and a more secure system. Customers are entering license agreements to secure additional options and then transitioning their licenses. We've been in this space for a long time, and while new workloads are important, they are minor compared to the existing data we've built up over the past several decades. The bulk of the activity stems from established databases rather than new workloads, with BYOL being more common than database services. Nonetheless, we are seeing exciting new workloads, particularly from startups, and we are actively pursuing them. Many of our new cloud customers are not existing Oracle customers, reflecting this shift. However, the majority of activity is happening within our existing installed base, where they are utilizing current licenses and acquiring additional options as they move to the autonomous database in the Oracle Cloud.

I have a question for Safra regarding the separation of cloud and on-premise sales, especially with the flexibility you provide through BYOL. At a high level, we understand your reporting changes, but how can you reassure investors that this isn’t masking any weaknesses in cloud performance? I'm specifically noticing that while we lack long-term deferred revenue data, the current deferred revenue is lower than we anticipated. I'm trying to prepare for potential questions tomorrow. I observed that when the key figures were released, your stock initially rose, but it later fell when more details became available. This might explain some of the market reactions.

All right. Let's review everything. First of all, there's no hiding here. I mentioned the cloud number is $1.7 billion. You can do the math and see we're exactly where we said we'd be, with no surprises. Margins have increased sequentially, indicating the business is performing well. Cloud billings are strong—very strong. You can hear that from our discussion about net deferrals. Gross referrals are actually up 5%. This is just a timing issue, and you'll see that from quarter to quarter, particularly from Q1 to Q4. So there's nothing unexpected here. We don't have any bad news. In fact, what we're conveying is that to understand our business better, especially with many customers taking licenses and support that were recorded as on-premise, we clarify that they are not deploying them on-premise. It simply isn't the case. We want to ensure you understand the business sufficiently to see that our customers are both purchasing licenses and utilizing licenses they already have, which are currently logged as on-premise and support. They are actually using those in the cloud, which is what they were designed for, and we are very excited about that. Given all the information I've provided, it’s quite clear we had an excellent quarter, and we anticipate the same for the next quarter.

That's helpful, Safra. But if you could just remind us when you refer to gross deferrals versus net deferrals, I know that you, Oracle, is probably more conservative than, I think, any company we cover in your reporting of deferred revenue. But if you could hit that quickly, that would be great.

Yes. I mean, from the gross deferrals, what we do is we subtract the uncollected, which is obviously a very big number at the end of Q4. Think about it. So that's all that's going on there.

John, just Mark. I'd add, there is just no story in the gross short-term deferral story.

Exactly.

Thank you, John. 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, and we look forward to speaking with you. Thank you for joining us today. And with that, I'll turn it back to the operator for closing.