Oracle Corp (ORCL) — Q3 2019 Earnings Call Transcript

Thank you, operator. Good afternoon, everyone, and welcome to Oracle's Third Quarter Fiscal Year 2019 Earnings Conference Call. A copy of the press release and financial tables, which includes a GAAP to non-GAAP reconciliation and other supplemental financial information, can be viewed and downloaded from our Investor Relations website. On the call today are Chairman and Chief Technology Officer, Larry Ellison; and CEO, 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 amendment 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 revision 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 Q3 results before moving on to guidance. I'll then turn the call over to Mark and Larry. As in prior quarters, I'll review our non-GAAP results using constant dollar growth rates, unless I say otherwise. Total Cloud Services and License Support revenue for the quarter was $6.7 billion, up 4% in constant currency, and now accounts for nearly 70% of total company revenue, largely recurring revenue. As in past quarters, we are seeing robust double-digit growth rates for total cloud revenue in all regions, with especially strong growth in Asia Pacific. In terms of product categories, ERP grew in the mid-30s and the verticals grew in the high 30s. Our software business, which is the totaling of Cloud Services and License Support revenue with Cloud License and On-Premise License revenue, is 82% of total revenue and it grew 3% in constant currency. Our software business has remained extremely stable and resilient as we have made the transition to faster-growing SaaS business that entailed trading nonrecurring upfront license revenue for recurrent long-term subscription revenue. Through adoption of autonomous database and OCI, we're now shifting the focus for our infrastructure business to the cloud. As a percentage of our total software business, cloud is now more than double what it was just 3 years ago and provides us with the ability to accelerate overall software revenue growth as this mix shift continues. GAAP applications total revenue were $2.8 billion, up 7%, and GAAP infrastructure total revenue were $5.1 billion, up 2%. 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 margins and continued investment in Oracle cloud infrastructure. Once our cloud business is at scale, I expect our gross margins will go significantly higher. Total revenue for the quarter was $9.6 billion, up 3% from last year. Non-GAAP operating income was $4.3 billion, up 5% from last year, and the operating margin was 44%, up from 43% last year. This quarter last year was greatly impacted by the change in the U.S. tax book, so comparing the GAAP numbers is not very meaningful after pretax income. The non-GAAP tax rate for the quarter was 20%, up from 16% catch-up rate last year, and non-GAAP EPS was $0.87 in USD, and up 12% in constant currency. This quarter, the GAAP tax rate was 11% and GAAP EPS was $0.76. Operating cash flow over the last 4 quarters is $14.8 billion. Over the last 4 quarters, capital expenditures were $1.6 billion and free cash flow was $13.2 billion, down 1% due to timing differences of tax payments and working capital items. We have more than $40 billion in cash and marketable securities. The short-term deferred revenue balance is $8 billion, up 5% in constant currency. The remaining performance obligations, or what I'll refer to as contract backlog, will be in the Q, and is now $31.5 billion, of which approximately 62% will be recognized as revenue over the next 12 months. Since 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 206 million shares for a total of $10 billion. Over the last 12 months, we repurchased 728 million shares and reduced the absolute shares outstanding by nearly 16%. And the Board of Directors increased the quarterly dividend 26% from $0.19 to $0.24 per share. Turning to currency. I expect the strengthening U.S. dollar will continue with a currency headwind of 3% for Q4 revenue and a $0.03 headwind to earnings per share. Okay, so with that, let me turn to the guidance. So for Q4, total revenues are expected to grow 1% to 3% in constant currency and 0 to negative 2% in U.S. dollars. Non-GAAP EPS in constant currency is expected to grow between 15% to 19%, and be between $1.08 and $1.12 in constant currency, so we will deliver double-digit non-GAAP EPS growth for fiscal year 2019. Taking into account the $0.03 currency headwind, non-GAAP EPS for Q4 in USD is expected to grow between 12% and 16%, and be between $1.05 and $1.09 in USD. My EPS guidance assumes a base tax rate of 20%. However, onetime tax events could cause actual tax rates for any given quarter to vary from our base tax rate. But I expect that in normalizing for onetime tax events, our tax rate will average around 20%. And with that, I'll turn the call over to Mark for his comments.

Thank you, Safra. We had a strong quarter overall. Our total revenue increased by 3% in constant currency, with Cloud Services and License Support growing by 4%, and EPS up by 12% in constant currency. In our applications segment, we maintained our momentum with a 7% growth, which accelerated our performance, resulting in over $11 billion in trailing 12-month revenue, with 92% of that now being recurring. We continue to outperform the market in revenue growth, and there is a significant opportunity ahead in ERP and HCM. SaaS revenue and bookings from Fusion apps rose by 35%. Our overall ERP and HCM annualized SaaS revenue has reached $2.8 billion, reflecting an increase in the mid-20s. Fusion apps grew by 35%, while Fusion ERP saw an organic revenue rise of 47%. NetSuite revenue increased by 28%, and bookings surged even higher in the mid-30s. Additionally, our vertical revenue rose by 38%, with annualized revenue in verticals exceeding $800 million. According to IDC's latest annual market share results, Oracle is the leading enterprise applications vendor in North America by market share and revenue, surpassing Salesforce.com and SAP. This growth has been expected, and it’s reassuring to see it reflected in independent numbers. In terms of infrastructure, our GAAP tech ecosystem reached $21 billion on a trailing 12-month basis, with Q3 up by 2%. We continue to build momentum in Autonomous Database, adding 4,000 new trials in Q3 alone and nearing 1,000 paying customers. We are bringing in many new customers, with a strong pull-through effect, and 20% of our autonomous data warehouse trials are also using analytics. We now have over 35 referenceable customers and expect to surpass 100 soon. Cloud customer revenue has increased by triple digits for the fourth consecutive quarter. Overall, it was a solid quarter as we met our revenue targets and achieved a 12% growth in EPS. The robust growth in our bookings and increasing renewal rates give me confidence that our cloud apps business will continue to strengthen, especially considering the visibility into our revenue backlog that Safra mentioned earlier. Looking ahead, I anticipate that FY '20 revenue growth will surpass that of FY '19, and EPS is expected to grow in double digits this year. I would like to share a few notable customer wins to give you a sense of our progress in the quarter, although many of these did not directly affect our revenue as they primarily reflect bookings. For example, Tromp Group in the Netherlands, MasterBrand Cabinets in the U.S., thyssenkrupp in Germany, and Willis Towers Watson are all migrating to the E-Business Suite. Additionally, we had PeopleSoft ERP migrations with Amica Mutual and DePaul University, plus wins like ON Semiconductor and Packaging Corporation of America, which are new customers for us in the ERP space. In HCM, we saw success with clients like Abu Dhabi Airports, ADT, Alorica, Banco Davivienda, BLOM BANK, Great Canadian Gaming, and a notable win with DeNova Healthcare, which was outside our traditional user base. We also had substantial wins on the platform side with names like Fair Isaac, Generali shared services in Italy, JOANN Stores, Trenitalia, and Unicorp, indicating a positive trend as we move towards our next generation of cloud and Autonomous Database offerings. I want to highlight our growing partnership with The Gap, a global retailer with revenue exceeding $16 billion. We are collaborating with them on their transformation into a multi-cloud environment using a range of Oracle Technologies for innovation, reliability, and scalability. The private cloud efforts are supported by Exadata, and we are excited to be Gap's strategic partner as they accelerate the launch of their new retail brands and stores. Overall, we had a solid quarter in terms of income and the quality of our bookings, and with that, I will hand it over to Larry.

Thank you, Mark. Oracle's future rests on 2 strategic businesses: cloud applications and Cloud Infrastructure. The growth in our cloud applications business has been driven by our Fusion Suite and NetSuite. Both the Fusion Suite of applications and NetSuite are growing very, very rapidly, and Mark gave you the numbers. As the names imply, both Fusion and NetSuite are integrated suites of applications, including sales, service, human resources, financials, supply chain and manufacturing applications. No other cloud services provider has such a comprehensive suite of applications covering both the front office and the back office. Most customers want their cloud services provider to make their applications work together. Customers do not like to be responsible for the complex process of integrating lots of different applications, running on lots of different vendors' clouds. We think our integrated suite approach to the cloud applications business is a primary reason for the very rapid growth in our cloud applications market share. The introduction of our Gen 2, highly secure infrastructure, featuring the Oracle Autonomous Database has been very well received. During Q3, we had nearly 1,000 paying Autonomous Database customers and over 4,000 active trials. Our infrastructure technology is highly differentiated from AWS. Each one of our cloud computers has a separate security processor and memory to insulate customers from intruding upon each other. And it also makes our cloud control code inaccessible to customers. No other cloud services provider offers this kind of protection across their entire public cloud. The Oracle Autonomous Database is the only database that can respond to a security threat by automatically patching itself while it's still running your application. No downtime is required. No other database has this capability. Oracle Technology leadership in cloud infrastructure and database plus our market leadership in cloud applications makes us very optimistic about our future. I'll turn it back to you, operator.

Operator, if we could move to the Q&A portion of the call, please?

Mark, I wanted to ask a question of you. Last month, when we were together at our tech conference, you reiterated that fiscal second half '19 sales growth would accelerate on a constant-currency basis versus the first half. And I'm not trying to be nitpicky but I think it doesn't look like it's accelerating much. So I was just wondering if anything changed. And I also wanted to ask about fiscal '20, which you've just mentioned that fiscal '20 constant-currency revenue growth would be higher than fiscal '19. I guess what I'm wondering is should we be thinking that, that constant currency growth acceleration that you're referring to for fiscal '20 is similar to the type of acceleration on the second half of fiscal '19? Or could it be more meaningful?

Yes, so let's go back to it. I think '19 will grow faster than '18. Second half is, whatever adjective is around it, grow faster than first half. FY '20, faster than '19. When you get in underneath at what are the drivers, at a big level, first, our growing businesses are becoming a bigger part of our total than our other businesses. So as an example, just one example, cloud ERP gets bigger, hardware gets smaller, obviously, those have offsetting effects. In addition, we have the things that attach with that, for example, our consulting services business now in on-premise has been declining, but our cloud consulting is inclining as does our overall bookings. So as a result, these just offset each other. Within it, clearly, I've given you the numbers on certain parts of our apps as the example of ERP and HCM, which are just growing substantially. Larry's comments about Autonomous Database are 2 huge drivers of growth as we go forward. So I think all of those statements, '19 versus '18, second half, first half, '19 to '20 are all where you're going to see acceleration of top line growth in CD.

So your aggregate results have been, I guess, relatively steady might be the right way to characterize it. And during this period, I think investors really appreciate the share buybacks and the dividend, nice dividend increase this quarter. I guess, I want to sort of follow on with that line of thinking, Mark, and this uptick in fiscal '20. And you talked a lot about your cloud apps and we get a lot of information on that, but can you talk a little bit about what extent the database options might be a driver to some of that revenue acceleration? And how big is the middleware business at this point?

I'll start and then Larry can add his thoughts on the off-trends. First, when we focus on the database side, the significant shift is towards autonomous technology. We attempted to share some figures indicating the level of interest. The surge in interest from the end of Q1 and early Q2 into Q3 was substantial. While this increase won’t be reflected in our revenue numbers just yet, I'm referring to trials, user testing, and, importantly, actual purchases. Notably, we've seen customers making initial purchases as small as $15,000 to $25,000 for the Autonomous Database, and within the same quarter, making additional purchases that escalate to $200,000 or $250,000. These are very promising early indicators for us. Additionally, as you mentioned, our offerings extend beyond just the database to include analytics and other services. As we continue converting trials into real usage, and that usage into expansion, this will drive our growth going forward. I'll let Larry elaborate on other aspects.

As people use Autonomous Database in the public cloud, they typically need to buy the multitenant option and the Real Application Cluster option, which are required options for Autonomous Database. So there's no question that the introduction of Autonomous Database and the consumption of Autonomous Database as that accelerates, will increase the license purchases of those 2 options.

Regarding the second part of my question, you mentioned that on-premise middleware wasn’t experiencing much growth or was even declining. Can you provide a rough idea of its current size? Mark, you hinted at some other businesses that are either not growing or are shrinking.

We don't typically disclose that, John. To my knowledge, I'm not going to start doing that today. However, it's clear that middleware is transitioning, similar to everything else, from on-premise to the cloud. We offer a comprehensive suite of cloud services, but we won't be separating it into a distinct business at this time.

Yes, I can tell you a couple of parts in middleware are doing quite well. I mean, I think it's a mixed story. I think analytics are doing very well in the cloud, as Mark mentioned, 20% of Autonomous Database goes up with analytics and, John, we had a very good quarter.

By the way, I wanted to mention that security is a rapidly growing part of our middleware business as well. The challenge with middleware is that it's not a single offering; it's made up of various products, some of which are experiencing significant growth while others are declining at the same time.

I just want to build on John's question there about the reacceleration ahead of us in database. When I think about what really differentiates Oracle and cloud, it's the Gen 2 OCI that we continue to get kind of increasingly positive data points on but then also adding autonomous platform on top of it. And so my question is with the TOMS data warehouse being out for a year and the transactional processing being out since August, how should we think about those 2 kind of combined to the reacceleration on top of ACI? And you mentioned the 1,000 customers and 4,000 trials, what is actually the driver of people shifting over? Is it speed? Is it cost? Is it performance? Just some more color on that would be great, so timing and then why.

I'll let Larry start.

The driver behind our success comes from various factors. Many customers are amazed that they can set up a database in just five minutes. We have been gathering feedback from 1,000 customers and 4,000 trials, noting their positive responses to the Autonomous Database. One significant aspect is productivity improvements. Customers can quickly log onto our cloud, create an instance, transfer their data, and start utilizing their database within five minutes, which has surprised many. Fast setup is a critical factor. For instance, one customer, previously using AWS, conducted a series of tests and discovered that our service operated 11.5 times faster than AWS while reducing their expenses by 80%. These customers, often academic researchers, are very budget-conscious, and the cost-effectiveness of the Autonomous Database compared to AWS services like Redshift or Aurora influenced their decision to switch. We're also seeing cases where customers with existing data warehouses appreciate the compatibility that allows them to seamlessly migrate their data. Overall, the three main motivators for adopting the Autonomous Database are productivity, compatibility, and cost.

We've never had a database release where we could truly engage with a CEO about its features and have them fully understand it. It’s not just about technical terms like partitioning; when we discuss that this database can self-patch, our customers at the CEO level now realize what a patch means and why it’s crucial and strategic. Many need to address it with their audit committees, and the ability to transfer patching responsibilities to us, ensuring it’s done instantly, has prompted numerous customers to say they would switch to Autonomous Database if that were its only feature. Additionally, as Larry mentioned, the database self-tunes, generates its own indexes, and is labor-free, allowing talent to be redirected elsewhere. Even if it only offered enhanced security and improved cost and performance, it would hold significant value. The enthusiasm surrounding this release is reflected in the high customer response, as it directly aligns with business needs. This isn’t something that’s being sold at lower levels; it appeals directly to the top executives. That’s why this release is so thrilling, as it delivers numerous business advantages to our clients, contrasting with the more traditional technical benefits we would often emphasize. It’s easier to explain the advantages we’ve detailed than to describe technical concepts like multitenancy or in-memory capabilities to a CEO.

Well, knowing how much we spend on patching, I've got a lead for your CRMs with them.

I'll stop there. I won't get too specific about your situation, but you are a strong example with a very large bank that has a significant amount of Oracle. They have done a fantastic job in many ways, but still have a window that needs to be closed. In terms of patch deployment, this is one way to accomplish that and the only method I know of to achieve it. So overall, a good solid quarter for us on the income statement side, but also in the quality of these bookings that we're describing or that I've been describing.

I wanted to return to the apps ecosystem. Mark, could you update us on NetSuite, which has seen acceleration again this quarter? A few quarters ago, we were aiming to reach over 20, but now we're in the high 20s. Was there anything notable contributing to this change, or should we be aware of any new run rates?

As I've mentioned in previous calls, they have been performing exceptionally well. This started with a remarkable acceleration last Q4 when their bookings growth exceeded 70%. You are beginning to see that translate into revenue now. I believe this new rate is sustainable, and I actually think we can improve further. Our strategy has been straightforward, simply involving the addition of sales personnel both internationally and domestically. We have localized the product for more countries and have launched in several new markets. Additionally, we have been developing more verticals through what we call SuiteSuccess, where we bundle implementation with our offerings. This approach has resonated strongly with our customers. I think the team has executed excellently. Moreover, while our revenue grew in the quarter, our bookings actually increased at a faster rate than revenue. We are very enthusiastic about NetSuite, and I believe they will continue to excel. In fact, I think we can achieve even better results than what I've just outlined.

You've been observing strong growth in cloud, ERP, HCM, and other cloud areas. Is this growth significant enough that we can expect an overall acceleration in the cloud business, despite facing some other challenges?

I mean, I guess I'll start. As I said in my comments, ERP and HCM are becoming a bigger and bigger part of our business. I mean, today, our annual SaaS revenues, ERP and HCM is approaching $3 billion. It's growing sort of mid-20s. And I think it's going to get nothing but better and better. Again, I don't want to get too positive. Only in the context that we're beginning to see acceleration in some key parts. So we're very focused on our competitors by brand and by industry. We deploy our sales force against those brands and against those industries as well as into our own user base. And the reason I read the references the way I read them was so you'd get a flavor that both our own user base is beginning to move in bigger numbers as well as the fact that we get competitive. Remember, most of that user base is not sitting with us or our traditional on-premise competitor. So yes, I mean, clearly it's a point to what I made earlier, and I'll stop after this to say that our growing businesses are becoming bigger and bigger, and you start putting the growth rates I'm describing on numbers like $3 billion, and you can do your own math. And so we're very confident, and feel very good about our position in those businesses.

Thanks, Mark. And if I get a follow-up quick one for Safra. Safra, you've managed to keep CapEx low even with the OCI investment. Any reason to expect a change in that trajectory, where we'd be spending more capital?

No. I expect it to be very similar this next quarter to this past quarter. And for the year, it's basically the same. Just a little bit less than last year. So that's kind of what we're looking at. Of course, if there's a huge opportunity, we may push the gaps a little more. But you have to understand that our SaaS operation is really, really coming, and we're getting enormous economies of scale there. That's why the margins keep improving, and so we're able to sort of do it all within the same investment envelope so far.

I'm going to do something I haven't done in a while, I'm going to take a bit of a liberty and ask 2 questions. The first is for Safra. You talked a bit on the call about cash flow, which has grown double digits, but was down roughly 1%, and you gave some color on the call, but can you talk a little bit more about the underlying factors here? Was timing or your definition of when you recognize cash flow having an impact? Are there other things that are impacting that cash? And then I have a follow-up for Mark.

There are two main factors at play. If we focus solely on the quarter, it primarily revolves around cash collections and the timing of those collections. That’s really the key point to consider. Looking at the year-to-date figures, there are cash collections along with some tax payments involved. Those are the two main elements we’re observing, so there’s nothing particularly unusual. It’s a scenario that occurs occasionally. If you review previous years, you’ll notice a similar pattern, especially in the third quarter, as we are typically collecting a significant amount from prior quarters’ billings. So overall, that’s really all there is to it—nothing out of the ordinary.

Okay, perfect. As a follow-up to Mark, can you discuss the types of workloads that are driving the adoption of the Autonomous Database, particularly among new clients for Autonomous revenue clients to the Oracle Database?

Larry?

I think the question police ought to get you for announcing you're going to ask 2 questions as opposed to just doing it.

Yes. No, that was very thoughtful. I don't know, maybe, Larry, you want to start in on that one?

There are many different things that databases can do. The researchers transitioning from AWS for significant cost savings are utilizing a mix of machine learning and computer vision to analyze tissue samples and identify abnormal cells. In cancer diagnostics, they are using computers to detect cancer through this combination of technologies along with the Autonomous Database. This represents a new application. We see numerous clients coming in with brand new applications in the cloud, particularly those shifting from AWS. Additionally, traditional on-premise customers are taking one of their many Oracle databases and simply migrating it intact. Whether it's a transaction processing system or a data warehousing application, they're transferring the data and the application to compute in the cloud and moving the data to the Autonomous Database, while running the same processes in the cloud. These customers are often witnessing significant performance enhancements; one customer reported that their cloud system outperformed their on-premise setup by a considerable margin. Furthermore, existing large Oracle customers are also migrating new developments. They are transitioning their test and development processes from on-premise to the cloud, resulting in increased productivity and cost efficiency. Overall, moving test and development online or lifting and shifting applications and data warehousing from AWS presents numerous different use cases.

I have a couple of quick follow-ups, Mark. Approximately 20% of our customers in the autonomous data warehouse or TOMS Database are new to Oracle; we did not have them before. About 80% are part of our existing user base, and roughly 70% to 75% of these cases have no competition at all; the transactions are simply migrations, as Larry mentioned. Additionally, 75% are targeting line-of-business rather than IT, which I see as very positive news. Overall, I believe we are witnessing improving dynamics in terms of acquiring new customers alongside the transition of our database, and certainly, analytical data warehousing is likely the most significant driver of our growth.

My question is for Mark. Mark, as we think about the traction you're seeing in cloud ERP and where the demand is coming from, there's the massive on-premise install base opportunity, but I think some might not appreciate that more than half the market is the long tail of niche legacy vendors that most people haven't even heard of. Can you just give us a sense for your success in displacing that long tail? How much you think you're participating there versus the more usual suspects?

I completely agree with your observation. It's widely acknowledged that the on-premise ERP market is largely controlled by two main vendors: Oracle and a German company. Together, these two hold less than half of the market share. Our clientele includes a greater number of Fortune 500 companies. While they do have several large clients, many companies, which account for over half of the market share, have transitioned into private equity. These firms are no longer public and are often on their second or third round of private equity ownership, lacking a clear migration plan to the cloud. This situation is prevalent among many legacy systems. Consequently, we strategically align our development and sales resources to focus intently on these competitors. Some examples include companies like McCormack & Dodge, IBM, Deltek, Lawson, and ETHICA, among others. Many of these legacy systems require modernization and represent a highly attractive market opportunity. Notably, our user base is well aware of our cloud roadmap and has confidence in our research and development efforts. They tend to feel less urgency to transition compared to those companies you mentioned, as they lack a clear migration strategy and are aware that their competitors are beginning to shift. As a result, our sales teams often express a preference for targeting these competitive territories involving niche vendors over more established ones, as there is a significant need for prompt migration. Therefore, this market is incredibly appealing, and it's a key reason we emphasize it so frequently. Additionally, we notice that when we sell ERP, there is a consistent increase in demand for HCM and even some of our other applications in the customer experience and front office areas, reinforcing our focus on this opportunity.

Okay, great. Thank you. A telephone 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. With that, I'll turn the call back over to the operator for closing.