Oracle Corp (ORCL) — Q2 2019 Earnings Call Transcript

Welcome to Oracle's Second Quarter 2019 Earnings Conference Call. Now I'd like to turn today's call over to Ken Bond. Thank you, Victoria. Good afternoon, everyone, and welcome to Oracle's Second Quarter Fiscal Year 2019 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 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 any 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. I'll first go over Q2 before moving on to guidance. I'll then turn the call over to Mark and then Larry for their comments. Let me start by summarizing that Q2 was another solid quarter. Constant currency revenue growth was slightly above the high end of my guidance and constant currency earnings per share was $0.02 above the high end of my guidance. As in prior quarters, I'll review our non-GAAP results using the constant dollar growth rate unless I state otherwise. Total cloud services and license support revenues for the quarter were $6.6 billion, up 5% in constant currency. This accounted for nearly 70% of the total company revenues and most of it is recurring revenues. GAAP applications' total revenues were $2.8 billion, up 7%; and GAAP platform and infrastructure total revenues were $5 billion, up 1%. Mark will go over more detailed revenue and bookings numbers in a moment. The gross margin for cloud services and license support was 86%, essentially the same as last year with continuing improvement in SaaS gross margins, stability in software support gross margin and continued investment in Oracle Cloud Infrastructure. As we continue to scale and grow our cloud business, I expect our gross margins will ultimately go higher. Total revenues for the quarter were $9.6 billion, up 2% from last year. Non-GAAP operating income was $4.1 billion, unchanged from last year, and the operating margin was 43%, the same as last year. The non-GAAP tax rate for the quarter was 18.6%, slightly below our base rate of 20% and non-GAAP EPS was $0.80 in U.S. dollars and up 19% in constant currency. The GAAP tax rate was 15.9%, and GAAP EPS was $0.61 in U.S. dollars, up 22% in constant currency. Operating cash flow over the last 4 quarters was $15.2 billion. Q2 operating cash flow was, in fact, negatively impacted by our first installment payment over $600 million on the one-time transition tax related to the U.S. Tax Cuts and Jobs Act of 2017. Over the last 4 quarters, capital expenditures were $1.5 billion and free cash flow was $13.8 billion, up 10% in U.S. dollars. We now have more than $49 billion in cash and marketable securities. The short-term deferred revenue balance is $8.2 billion and that's up 6% in constant currency. The remaining performance obligations or what we'll refer to as contract backlog will be in the 10-Q and is now $30.1 billion, of which approximately 62% will be recognized as revenue over the next 12 months. We remain committed to returning value to shareholders through acquisitions, internal investments and a return of capital with stock repurchases and dividends. This quarter, we repurchased 203 million shares for a total of $10 billion. Over the last 12 months, we have repurchased 602 million shares and reduced the absolute shares outstanding by over 12%. The Board of Directors, again, declared a quarterly dividend of $0.19 per share. Turning to currency, I expect the strengthening U.S. dollar will increase the currency headwind to 4% for Q3 and a $0.03 headwind to earnings per share. So for Q3, my guidance is, total revenues are expected to grow 2% to 4% in constant currency. I continue to expect the revenue growth will be higher, and we remain committed to delivering a higher constant currency growth rate for all of fiscal 2019 when compared to last fiscal year. You may remember that last year's Q3 EPS included some one-time events, which I called out at the time, which helped by about $0.03 last year. In addition, my EPS guidance assumes a base tax rate of 20%, which is nearly 4 points higher than last year because last year's tax rate was a catch-up quarter for the new tax law. Certainly, one-time tax events could cause actual tax rates for Q3 to vary from the base rate. But I expect that in normalizing for these one-time events, our tax rate will average around 20% for fiscal year 2019. Okay. With all that, for this quarter, non-GAAP EPS in constant currency is expected to grow between 7% to 9% and be between $0.86 and $0.88; and non-GAAP EPS for Q3 in U.S. dollars is expected to grow between 3% to 5% and be between $0.83 and $0.85. And while my double-digit constant currency EPS growth guidance for fiscal year '19 has not been a specific number, I can tell you that internally I have, in fact, raised my fiscal year '19 constant currency EPS growth rate estimates. And with that, I'll turn it over to Mark for his comments.

Thank you, Safra. We had a solid quarter across the board. Total revenue increased by 2% in constant currency, with cloud services and license support up by 5%, and EPS up by 19%. This marks our seventh consecutive quarter of double-digit EPS growth. Our applications performed exceptionally well, showing 7% growth across the ecosystem, with trailing 12-month revenue exceeding $11 billion, of which 91% is now recurring. We're outpacing the market in revenue growth, and we see significant opportunities ahead, especially in ERP and HCM. Regarding our SaaS business, ERP and HCM annually have a SaaS revenue of $2.6 billion, growing in the mid-20s percent range. Fusion apps saw a revenue growth of 34% and Fusion ERP grew by 44%, all organically. NetSuite ERP revenue rose by 25%, while vertical revenue and applications increased by 35%, with an annualized revenue now at $800 million. Regarding SaaS bookings, it's worth noting that this didn’t directly reflect in our revenue. The growth rate for ERP and HCM bookings has accelerated over the last four quarters, now reaching the high 30s. Additionally, we experienced a significant shift with nearly 200 installed base customers transitioning to ERP cloud in this quarter, which, of course, affects bookings rather than revenue. Our SaaS net bookings, factoring in non-renewals, were the highest in company history for a non-Q4 quarter, with growth also in the high 30s percent. Our tech ecosystem GAAP revenue was $21 billion on a trailing 12-month basis, showing a 1% growth in Q2, with database new license support revenues increasing modestly. Larry will discuss Autonomous Database in detail soon. We currently have over 1,000 trial activations per month for data warehouse and transactional use, and that number keeps increasing. Our Cloud at Customer solution is also performing well, with revenue growth in triple digits and bookings up by low 40 percent. I’d like to highlight some customer wins this quarter that contributed to our app numbers. MGM Resorts is one example; we provided a full suite including supply chain that replaced an existing product. We also secured a significant win at a large distribution company with a complete suite sale, linking ERP and HCM as there’s a demand for a unified user interface and workflow. Another noteworthy win was with Johnson Controls, where we supplied both service cloud solutions and ERP. Hormel also chose our full suite of ERP, including HCM. Securitas, a well-known security provider, and Helzberg Diamonds made full suite decisions as well. Indiana University Health Center transitioned from Lawson to our full suite, which included ERP and HCM. There were numerous other wins worth mentioning such as Littlewoods, Samsonite, and the European operation of Toyota, all contributing to the biggest net bookings we’ve had outside of Q4, supported by these quality wins. Before I conclude, I want to share a survey insight from IDC. They conducted a study of 276 HCM SaaS customers regarding their experiences with various vendors. The results indicated that Oracle's SaaS HCM received the highest ratings among competitors in several categories such as vendor satisfaction, likelihood to recommend, data security, and ease of use. I wanted to convey that this feedback comes from an independent source. In summary, we had a solid quarter with a 19% EPS growth and 10% free cash flow growth. The robust growth in bookings, along with increasing renewal rates, gives me confidence that our cloud apps business will continue to strengthen. This quarter has arguably been our best for app bookings, with a wide range of bookings and strong insights into our revenue backlog. Looking ahead, we expect full-year revenue growth to surpass last year, and EPS to grow in double digits for the year. Now, I’ll hand it over to Larry for his insights.

Thank you, Mark. Oracle has 2 strategic products that will determine the future of our company: Cloud ERP and the Autonomous Database. Virtually every technology analyst organization agrees, Gartner, Forrester, IDC and the rest. Please read the published reports that Oracle has developed the world's most advanced ERP technology. Featuring an easy-to-use voice interface and machine learning-based artificial intelligence to automate many formerly manual ERP processes. But more than being simply the technology leader in ERP applications, the analysts also confirm that Oracle has translated that technology leadership into market leadership in cloud ERP with nearly 6,000 Fusion ERP customers plus more than 16,000 NetSuite customers and we are adding about 1,000 new cloud ERP customers every quarter. Technology analysts also agree that Oracle's new Autonomous Database gives Oracle the largest technology lead we have ever enjoyed over our database competitors since we entered the database market almost 4 decades ago. As we pair our new Autonomous Database with our new Generation 2 Cloud infrastructure, we expect not only to hold onto our 50% database market share, we expect to increase it. That means millions of Oracle databases will move to the Oracle Cloud. Those are the 2 strategic initiatives that we are focused on. One, continue to expand our market leadership in cloud ERP, which should make us the world's largest cloud application company. And two, maintain our database technology leadership and migrate our 50% database market share through the Oracle Cloud. We're optimistic about our ability to deliver on these 2 strategic initiatives and our ability to be the leader in these 2 key market segments. With that, I'll turn it back over to Safra.

Okay. So I think we're ready for questions.

We're now ready for Q&A, Victoria.

SaaS ERP is the largest growth driver within SaaS and we believe within your total apps business, but there are so many moving parts that it's not obvious in the reported results. Can you give us a sense of when you expect that SaaS ERP will be large enough and growing fast enough to start to visibly improve year-over-year revenue growth first in SaaS and then in overall apps? And then as a quick follow-up, can you give us any color on the timing of conversions from book to revenue, has it improved or not?

The answer to both questions is no. Just kidding, Mark. It's the holiday season, so I thought I'd share some festive thoughts. Firstly, our NetSuite performance has been impressive, which is just one aspect of it. When we acquired NetSuite, its growth rate was around 15 percent. As I mentioned during our call, their bookings started to improve significantly in Q4 last year, followed by a strong Q1, and they had another robust bookings quarter in Q2, with their revenue growth now reaching approximately 25 percent in the quarter. This is significant for us regarding scale and growth rate. I don't want to say I have higher expectations, but I maintain high hopes that they'll sustain the momentum we've seen, suggesting increased growth rates. The growth rate of Fusion in ERP is even higher than that of NetSuite. I hope my description of the quality of our wins gives you a sense of how well-received that solution is in the market. When we consider the two together, our target is that we might approach close to $1 billion in growth next year from these two solutions. I'm not providing a specific number, but I want to emphasize the opportunity we see on a larger scale. Additionally, one thing I want to highlight from the wins we're discussing is that when we sell ERP, the demand for us to offer other solutions alongside is only increasing as we identify more opportunities in the marketplace. Does that answer your question?

Helps to point me in the right direction.

Larry, I think we all appreciate how sticky Oracle database is given it stores some of the most valuable information in the world, but the competitive noise in the market just keeps getting louder and louder. What's your latest thinking on the competitive dynamics for the database?

There is a recent Gartner report that highlights the ranking of database technologies, placing Oracle at the top with a significant lead, followed by Microsoft at a distant second, IBM in third, and Amazon far behind despite their noise in the market. We believe our technology leadership in databases far surpasses that of Amazon. Amazon has repackaged open-source databases like MySQL for their Aurora service and borrowed from open-source systems for Redshift, essentially renaming and hosting them in their cloud. While they were the first to offer these services in the cloud, transitioning from an Oracle database to an Amazon database is extremely costly and complex, requiring sacrifices in reliability, security, and performance. We possess a substantial technological advantage. The Oracle Autonomous Database has never been stronger from a technology perspective, according to the Gartner report. Success in the cloud business hinges on delivering this Autonomous Database alongside top-tier cloud infrastructure. We now have that with our Generation 2 Cloud. You will observe a swift migration of Oracle databases from on-premise systems to the Oracle Public Cloud and Oracle Cloud at Customer. We believe we are not just going to maintain our 50% market share but are also poised to grow it.

Listen, my question is sort of a follow-up to Brad's. And Larry, and I think it's more for Mark and maybe Larry, too. We understand your focus on moving your 50% relational database market share to the Oracle Cloud, but that's going to take time for your customers to get there. And until then, they're likely considered by for on-premise deployments. This quarter, platform and infrastructure grew 1% constant currency. Realize there's headwinds in there from, like, the middleware business and probably some other things, but more interested in the database, as you say Larry, that's one of the strategic products that has to be successful here. Can you give us some more color on the database in this quarter especially for the options? And the 2 that standout for me are multi-tenancy and then memory, but I know there's others that are associated with the Autonomous Database. I mean, these are 2, but others that are really specifically there. And I guess, when will we see those tailwinds from whatever middleware and whatever else is causing them to subside in that part of the business?

Larry will start and then I can follow up with some numbers for you, John.

The database options grew about 4% in the quarter, and we've always had growth in the database license business. The challenge has been ensuring our cloud infrastructure is robust enough to support our database, and we achieved that several months ago. Our Generation 2 infrastructure is now in place, enabling us to run thousands of Oracle Autonomous Database trials for our customers. They can transition from on-premise to the Autonomous Database very quickly; it’s not a major technology upgrade, just an update by moving data and adjusting a few indexes. We anticipate significant growth for the Oracle database in the Oracle Public Cloud next fiscal year, which ties into when ERP will start making a substantial impact. Mark mentioned we have a chance to reach that billion-dollar growth rate next year, and we believe we can achieve similar progress with the Autonomous Database.

I would like to add a couple of points to what Larry mentioned. We have not experienced a quarter where the database license and our support business did not grow. Also, regarding the options, the autonomous options have actually seen the fastest growth among them. While the trials are as I mentioned, having thousands of trials that are increasing monthly is significant for next year's revenue impact. The options, such as Active Data Guard and multi-tenant, are really driving the growth in options that Larry referred to.

Just wanted to follow up on, Larry, your last comment there about the Autonomous Database. I mean, obviously, the transactional database just came out in August and the data warehousing one earlier this year, but what has the feedback been from customers? Sort of why is the interest level growing? Is it cost? Is it the availability, et cetera? Maybe just some more color on sort of what you're hearing from clients now that the 2 options have been live out there. And then just to your point there about sort of the adoption life cycle, wondering if you can step us through that, like, what are the key milestones you think sort of customers need to see to then start hitting sort of the inflection point on adoption?

I initially thought that the main factor driving the use of autonomous technology would be the reduction of labor costs. Eliminating human labor would lead to lower costs and fewer errors. However, what has truly been driving this adoption is increased productivity. Customers have reported being able to get their databases operational in just 15 minutes. Existing customers and database administrators have managed to set up another system in the same 15 minutes, whereas the average setup time for such systems was typically around 15 days. The ability of these existing teams of database administrators, who are our primary customers, to dramatically enhance their productivity and achieve ten times more within the same timeframe than they could before adopting the Autonomous Database has been the most surprising aspect for them. This increase in productivity is what we believe will more significantly influence the migration to autonomous technology, rather than simply closing data centers and cutting labor costs.

This is a question for Safra and Mark. It's obviously a very turbulent market out there. So I'd kind of appreciate it if you could both tell us a little bit about what you're hearing from customers when you meet with them. What are they telling you about how they see the world in light of all the volatility that's going on?

Well, many of our customers, especially those moving to SaaS and moving to the cloud are looking for ways to increase productivity, to spend a lot less money running their back offices and to get real business insight from the technology, and there is an immense amount of excitement around it, frankly. In fact, a number of our customers that may use one of our cloud products are now moving to our other cloud products without even doing a full RFP and competitive analysis because they've been so satisfied with our products. In fact, just today I got a call from a very well-known company and they've already picked our ERP and were so happy they're just going to roll out HCM and supply chain management now next. So there is a lot of enthusiasm around our products as a general matter, regardless of the economy, our products save them money. So it gives them more money to invest in other things and that's what, obviously, I focus on with them.

I'd say, Sarah, most of our customers want to concentrate on their business and its growth. They are focused on their customers and how to generate revenue. In today's business IT landscape, most of the large budgets are allocated to maintenance—keeping existing applications and infrastructure operational—leaving little room for innovation. The opportunity with our products is to fundamentally change their approach, allowing them to redirect IT budgets into our R&D budgets, which is very appealing to our customers. This shift in responsibilities means they can invest less while simultaneously benefiting from innovations. Fortunately, this concept is becoming more mainstream, and I’ve noticed in recent conversations that I’m spending less time educating customers and more time discussing solutions. Just last week, during my trip to the Midwest, I engaged with many customers without needing to evangelize as much. Instead, we focused on how we can help them save money while achieving greater innovation, which reflects a significant evolution in the market. Additionally, customers are eager to move away from data centers, servers, and outdated infrastructure, which typically do not support their business advancement. Providing them with solutions that save money and promote innovation is a major development that our customers are actively discussing.

Given that the comparisons are becoming easier for the apps ecosystem in the second half, there seems to be potential for further acceleration. Could you elaborate more on the ERP NetSuite strength? You have 16,000 customers, which indicates a significant market, and it appears to be reaccelerating. Can you provide more insight into what is working well there and how large that market could grow over time?

Well, sort of everything. To be clear on NetSuite, there are three core tenets we focused on when we acquired it. First, we believed they were underserved in terms of sales resources in the marketplace. We have dramatically increased that, both domestically and internationally. A lot of the growth in NetSuite is not just from international markets; there's been significant growth in the United States simply by getting them more customers. We've also expanded their resources internationally. Second, we've increased their R&D to reach more countries. We have released updates and are now covering more regions than we were previously. So we have more salespeople with more products available in more locations. Third, we are focused on industries; we go into specific micro segments in the marketplace, like campus bookstores, and develop features tailored for those distinct segments. These three fundamentals—more sales resources, more countries, and more micro segments—are key to our strategy. By the way, we apply a similar formula with Fusion, which follows the same principles. The NetSuite team has done an outstanding job, and I am thrilled with their performance and future prospects.

If Autonomous Database does as well as you expect, what's the impact of that on Infrastructure as a Service? Is there a feedback there?

Yes, we believe that Autonomous Database and Exadata services will represent between one-third and one-half of our Infrastructure. Clearly, this will be a significant driver for our infrastructure. If we were to focus solely on running Oracle applications in the Oracle Public Cloud, including those of our independent software vendor partners, we would surpass Amazon by more than ten times. However, we have greater ambitions beyond that. While we also have a substantial SaaS business, the Oracle database will play a crucial role in driving the infrastructure business, potentially comprising around 50% or even more of it.

Okay. I think that's it for us. Let me just say one other thing: if the Autonomous Database performs well, our margins on PaaS and IaaS will increase significantly. So, as our infrastructure grows, not only do revenues rise, but margins also see a substantial boost.

Okay. Thanks, Safra. 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 question on this call. We look forward to speaking with you. Thanks for joining us today. And with that, I'll turn the call back over to Victoria for closing.