Oracle Corp (ORCL) — Q1 2020 Earnings Call Transcript

Welcome to Oracle's First Quarter 2020 Earnings Conference Call. I'd now like to turn today's call over to Ken Bond, Senior Vice President. Ken? Thank you, Holly. Good afternoon, everyone, and thank you for joining us on short notice. Welcome to Oracle's first quarter fiscal year 2020 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. 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 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, and thank you all for joining us on such very short notice. Of course, September 11th is an important day for our country and for us at Oracle. Many of you know that we lost 11 of our employees and many friends that day, and we honor all the victims today and every day. May their memories be a blessing to all of us. We originally planned to hold this call tomorrow. However, as Mark will be taking a leave of absence for health-related reasons, we felt it made sense to share all of our news at once. Mark was extremely engaged with the business through the end of the quarter, but now he needs to focus on his health and taking care of himself. As the three of us have always worked as a team on managing Oracle, Larry and I will cover Mark's responsibilities during his absence with the support from the rest of our strong management team. Now, switching to the first quarter, I will review our non-GAAP results using constant dollar growth rates unless I state otherwise. And though the effects of the currency movements in Q1 were modestly more than expected with a 1.3% headwind to total revenues and $0.01 headwind to earnings per share, both results were in line with my guidance range. Total Cloud Services and License Support revenues for the quarter were $6.8 billion, up 4% and accounting for nearly three-quarters of total company revenues and most of this revenue is recurring. Cloud and On-Premise License revenues were $812 million, down 6%, coming off 15% license growth last quarter. And as a reminder, because Q1 is normally our smallest quarter, we tend to see more volatility in new software license growth rates in Q1. In terms of ecosystems, GAAP applications ecosystem revenues were $2.8 billion, up 3%, with Fusion apps up nearly 40%, including Fusion ERP, up mid-40s, and Fusion HCM up low 30s. NetSuite ERP was up in the mid-20s. Vertical SaaS was up high single digits while Data Cloud was down in the low teens. On a trailing 12-month basis, more than 90% of our application ecosystem revenue is now recurring. GAAP infrastructure ecosystem revenues were $4.8 billion, up 3%, with total database revenue up similarly, highlighted by BYOL and Autonomous Database revenues, both up triple digits, but also from a small base for now. On a trailing 12-month basis, more than three-quarters of our infrastructure ecosystem is now recurring. In terms of geographies, we saw double-digit revenue growth in cloud revenue in all regions, with especially strong results in Latin America and Asia Pacific. The gross margin for Cloud Services and License Support was 86%. And as we continue to scale and grow, I expect our cloud gross margins will go higher, driving an acceleration in our gross profit growth. Total revenues for the quarter were $9.2 billion, up 1% from last year. Non-GAAP operating income was $3.8 billion, up 4% from last year; and the operating margin was 42%, up from 41% last year. The non-GAAP tax rate for the quarter was at 9.8%, slightly below our base tax rate of 20%, and EPS was US$0.81, up 16% in constant dollar and 14% in US$. The GAAP tax rate was 13.9% and GAAP EPS was US$0.63, up 13% in constant currency and 11% in US$. Operating cash flow over the last four quarters was $13.8 billion. Over the last four quarters, capital expenditures were $1.7 billion and free cash flow was $12.2 billion. We now have approximately $36 billion in cash and marketable securities, and the short-term deferred revenue balance is $10.9 billion. As we've said before, we're committed to returning value to our shareholders through technical innovation, strategic acquisition, stock repurchases, prudent use of debt, and the dividend. This quarter, we repurchased 89 million shares for a total of $5 billion. Over the last 12 months, we've repurchased 611 million shares for a total of $31 billion. And over the last five years, we have reduced the shares outstanding by more than 25%. The Board of Directors increased the authorization for share repurchases by an additional $15 billion and again declared a quarterly dividend of $0.24 per share. My guidance today is on a non-GAAP basis and in constant currencies. Assuming current exchange rates remain the same as they are now, currency should have a 1% negative effect on total revenue and $0.01 negative on EPS. Of course, that could change. So, for Q2, total revenues are expected to grow 1% to 3% in constant currency. And assuming a 1% currency headwind, total revenues are expected to grow from 0% to 2% in U.S. dollars. Non-GAAP EPS in constant currency is expected to grow between 10% to 12% and be between $0.88 and $0.90 in constant currency. And assuming the $0.01 headwind, non-GAAP EPS in U.S. dollars is expected to grow between 9% and 11% and be between US$0.87 and US$0.89. For fiscal 2020 and the third consecutive fiscal quarter, I expect that we will report double-digit EPS growth in constant currency. Total CapEx for the fiscal year 2020 is expected to be around $2.2 billion, but it could move a little depending on our bookings, and how much we need to invest to accommodate them. My EPS guidance for Q2 and fiscal 2020 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 these onetime tax events our tax rate will average around 20% for fiscal year 2020. I'm turning the call over to Larry for his comments, who will spend a little time highlighting some of the key wins we had during the quarter with emphasis on back-office applications, and then talk about autonomous database.

Thank you, Safra. As you know, our back-office applications business has been experiencing significant growth for several quarters. We see a tremendous opportunity in both ERP and HCM. We have a large installed base of ERP and HCM customers transitioning to the cloud, and more than half of the current market is dominated by companies without a SaaS upgrade option, making their products susceptible to replacement—a process we are actively undertaking. Our investments in Fusion have driven strong back-office performance in recent years and have positioned us to not just be the largest back-office player in the cloud, but the largest overall. Here are some notable Fusion ERP wins from Q1: DP World, Shaw Communications, Bangkok Bank of Thailand is upgrading to our Fusion Financials Cloud Service, Envision Healthcare where we surpassed Workday and are replacing their legacy system, Express Scripts is migrating from Hyperion to our Fusion EPM in the cloud, and Lyft has transitioned some of their ERP from NetSuite to Fusion as they prepare for growth. We also scored wins against Workday with Media Newsroom and National Oilwell Varco, which is expanding their use of our products. NGL Energy Partners has purchased our Fusion ERP suite, and Penn National Gaming won against a German competitor. Standard Group Limited, a garment manufacturer, also chose us over the same German company. Southern Company is moving from the E-Business Suite and PeopleSoft systems to our Fusion Cloud suite for overall financials and HCM. We're also seeing great success in HCM, with BAE Systems choosing Fusion HCM to enhance their HR technology. Dubai Holdings is expanding by adding Fusion HCM and Taleo, and Envision Healthcare is also integrating Fusion HCM with their ERP. A major UK transportation entity is transitioning to our Fusion suite from their E-Business Suite. McDonald's has chosen our HCM and payroll, winning the competitive bid against Workday. Southwest Gas is moving from SAP on-premise to the cloud with us, and we're collaborating with the University of Texas to provide support for their migration from PeopleSoft. Our success is being recognized by industry analysts, with Oracle SaaS receiving the highest rating in IDC's 2019 survey. We are at the forefront of a back-office upgrade cycle that will enhance our application ecosystem for years ahead. We are already the largest ERP system in the cloud and will soon be the largest ERP provider overall. Now, I'd like to discuss the Autonomous Database, which we see as a game changer. Autonomous technology is what sets apart the second-generation cloud from the first. While the first-generation cloud offered rental and pay-per-use models, the second generation not only provides pay-per-use but also eliminates the manual labor associated with managing the cloud, leading to substantial economic savings. Moreover, a second-generation autonomous cloud significantly reduces risks like data theft, which manual processes cannot adequately prevent. The Oracle Autonomous Database prevents human errors that could lead to serious data breaches, such as the incident with Capital One, because it automates the necessary configurations and maintenance. Unlike manual systems, it performs tasks like patching and backing up automatically. If you want to curb data theft, employing an Autonomous Database is crucial. We're still early in the adoption of the Autonomous Database, which was announced in 2017 and has been gaining traction as one of our most successful product offerings. Recently, in Q1, we added over 3,700 new Autonomous Database trials, bringing our total to over 2,000 paying customers. Many of these customers were new to Oracle, with 13% never having purchased an Oracle database before. A notable portion of workloads being moved to the Autonomous Database are entirely new applications. We achieved over 500 wins for the Autonomous Database this quarter, including clients like 7-Eleven, Cargojet Canada, Johnson Controls, and LATAM Airlines, as well as Siemens Energy and Stanley Black & Decker. Notably, Uber is also transitioning to the Autonomous Database. Now, let's return it to the operator.

Thank you, Larry. Holly before we go to the Q&A, just a couple of clarifications, because I had a couple of emails on this. The non-GAAP tax rate for the quarter was 19.8%. And then for fiscal year 2020, we expect for the full year, this will be our third consecutive year of double-digit earnings growth. With that, Holly, why don't we turn up to Q&A?

Thank you. I want to take a moment to express that our thoughts and prayers are with Mark and his family at this time. However, knowing Mark for many years, I think he would want us to return to business, so I will jump straight into the question. Cloud Services and License Support performed well this quarter, but License did not meet our expectations. I understand that the first quarter is typically slow, especially following a particularly strong fourth quarter. Can you provide any additional insights on this? For example, BYOL has gained quite a bit of traction, right? Could that impact your financials and lead to seasonal trends similar to what we have seen in the past? It seems to be leveling out a bit, although still seasonal. Should we start thinking of Oracle's seasonality in a way that reflects its previous patterns, or are you also experiencing macro pressures as mentioned by other companies? Any insights you could share would be appreciated.

Sure, John. It was actually quite simple. Outside of North America, our licenses increased significantly internationally. In North America, we did make changes to our salesforce. We had previously mentioned that we would split the tech salesforce into two groups: one focused on cloud sales and the other on new licenses. The new licenses group is just starting, so I expect they will recover throughout the year. That was the only challenge we faced, which was simply a slow start due to the reorganization of the salesforce. There are no macroeconomic issues or regular challenges. Also, in Q1, small changes can have a large impact, so the numbers appear more significant than they actually are. However, we are not seeing any problems, and that was all there was to it.

Okay, that's really helpful, Safra, and it makes sense. We're hearing things about that. I have a quick follow-up for Larry. Last quarter, you had strong results in the database options, particularly with the Autonomous Database. I'm curious about this quarter. It's a seasonally softer first quarter, but can you talk about the options themselves? I'm thinking more about things like multi-tenancy, which is my favorite, but there are others that are important too.

I believe that multi-tenancy in memory and all the database options associated with the Autonomous Database are performing exceptionally well. The recent reorganization in North America significantly influenced this, as these are license sales that transition to the cloud. Customers are purchasing multi-tenant options, racks, and in-memory solutions, and then transferring their existing licenses to the cloud. Some of those sales experienced delays due to the reorganization, but we see tremendous demand. A strong indicator of this is the number of trials we established in Q1. Our cloud sales team experienced remarkable activity, leading to more than 500 signed Autonomous Database deals and 3,700 new trials in Q1. We anticipate that the number of paying customers will double in Q2, which will boost our pipeline. This serves as a solid early indicator, contributing to both cloud revenue and license revenue from these options.

Next question, please.

Great. Okay. Thank you.

Great. Thanks so much. I'll start just by echoing John's sentiment and wish Mark a very speedy recovery. But getting on with business, I wanted to dig in a little bit to the great momentum that you're seeing in cloud ERP? And you gave a lot of color Larry in your comments, but perhaps if you can help us understand what the demand patterns look like amongst existing customers migrating versus new logo business that you're able to attract. And as well, that market has always been a fragmented market. And is there any evidence that you might be benefiting from consolidation finally in ERP which has so many players that's in the long tail? Thank you.

I would like to discuss some of the recent consolidations. We are focusing on Lawson. We have sales territories specifically for Lawson Healthcare, and we have consolidated several of those territories. Approximately one-third of Lawson Healthcare's customers are now part of our pipeline, either converted or in the process of being converted, and we anticipate winning all of them. Additionally, we have introduced new sales territories for Lawson retail, which combines our Fusion Financials and retail merchandising products. We believe Lawson is a vulnerable company that has struggled to build cloud systems, a challenge I can personally attest to from experience. It took Fusion ten years to launch, which is significant. Companies like NetSuite and Salesforce also took over 20 years to develop their systems. Lawson currently lacks a comprehensive solution. We are capturing many of their customers. Notably, SAP does not possess a genuine cloud system; they only offer some hosting services. We are now seeing medium to large companies choosing us and successfully converting them. We are also in discussions with some of SAP's largest clients and are in the process of converting one of them, which we see as a major opportunity. Currently, Oracle and SAP control about half of the European market, while the other half remains highly fragmented. We initially targeted the weaker companies in that fragmented space, and we believe there is an opportunity to consolidate further. I'm almost hesitant to mention our ERP and cloud market share, but it is significant, around 95%.

A lot.

I mean, I don't know. I mean just, I'm guessing, but I don't know because I don't know of any other cloud ERP system other than NetSuite and Fusion, so maybe 95% is low. I mean, it sounds a little crazy. But SAP really did not rewrite their code. They really don't have a cloud system. And we have an opportunity to go after them and just put that aside, and then that whole other half of the ERP marketplace, which is companies that a lot of people have never heard of. And yes, I think we can consolidate virtually all of that. I mean, I don't know how to describe it. It's a crazy opportunity. You don't see this happen very often.

Next question, please.

Thank you.

Hey, thanks for taking my question. I just wanted to echo Mark just wishing you the speediest recovery and all the best. And to the team, congrats on a solid start to the year. I just wanted to follow up on John's question on the database. One of the questions I get from investors is sort of the trajectory of database because obviously we're getting some metrics from you guys, that's showing an inflection in terms of customers, also just trials out there. How do you think about just, I guess, the shape of the curve of database growth going forward with all these different levers?

The growth rate is remarkable, but we're not forecasting it. When Safra provides a forecast, it doesn't encompass the steep growth curve in Autonomous Database. We're adopting a conservative perspective, particularly regarding Autonomous Database. We possess technology that no one else has, and currently, we are the leading database supplier globally, larger than IBM and Microsoft combined. Historically, we were also bigger than both of our largest competitors during the on-premise era. Though there are several open-source cloud databases and specialized options, none are autonomous, secure, or able to operate without human intervention. They also do not offer 99.995% availability. Our system is significantly more reliable—about 100 times more so. We have a unique system that ensures data security by automating decisions, eliminating human errors. This gives us a significant opportunity to dominate two markets: ERP, where we have a strong presence and clear data trends, and Autonomous Database, where we are still in early stages and have limited data. While the outlook in Autonomous Database requires patience, we have a substantial installed base that I believe will transition to it. Additionally, the fact that it is not safe to choose any other database serves as a strong differentiator. Success in both ERP and Autonomous Database markets should be sufficient for our growth.

Thanks, guys.

Great. Thank you so much. And again, I'm going to echo everyone's thoughts for Mark and thoughts with him and his family. Just wanted to ask two quick questions. One, if I could, Safra, I know John DiFucci asked some questions about the environment. You talked about the North American sales reorg. I was wondering, just you've seen a lot of results since August, early August come in where maybe results haven't been as good as people wide. I'm just wondering if you're seeing – if you saw any elongation in the sales cycles, if there's anything you can share with us there just globally from what you've been seeing. And then secondly, just a question related to OCI and – I know obviously Open World's next week. There'll be a lot of partners to talk to. But a lot of the partners we've been speaking to of late have talked about a real pickup in momentum there. And just wondering, if you can share with us what you're seeing? Thank you.

Sure. Actually, we feel like we've got a lot of momentum here at Oracle. The issue regarding markets either abroad or in the United States we're not seeing it. The – we're on very, very positive momentum from a product cycle point of view. Our Fusion products are basically killing it. That's doing amazingly. The Autonomous Database and the whole OCI is so compelling. And we are in the field, and we are expanding globally that we have just so much good news happening around the world that we're not seeing the weaknesses. And so to the extent that there are, we just have a lot of company, product, momentum ourselves; I know that I will not be able to hold Larry back from answering your second question, so I'm just unleashing him in advance of Open World. Go ahead, Larry.

Next week at Open World, we will discuss the improvements we've made to Autonomous Database, which we began in 2018. However, our focus will not solely be on Autonomous Database. We will unveil several new autonomous services at Open World, a concept no one else is pursuing. We aim to leverage our machine learning technology to create a variety of autonomous services. Our ambition is to provide the world's first entirely autonomous cloud, an essential aspect of secure data management. We believe that having an autonomous operating system and multiple autonomous services will minimize the chances of human error, allowing developers to focus on application building instead of managing the complex and error-prone infrastructure of the cloud. Our goal is to reduce costs and eliminate mistakes. Starting with Autonomous Database, expect several announcements regarding new autonomous services in OCI. OCI is experiencing significant momentum. When people explore Autonomous Database, they also notice our analytics and compute capabilities. We have developed a second-generation cloud that stands out from competitors like Amazon and Google.

Thank you.

Next question please.

Thank you very much for taking question. Again, I echo everyone else. Please tell Mark that our thoughts are with him and his family. Larry, Safra, given autonomous adoption commentary how good it's going, can you give us some more color based off this quarter on how the revenue lift is occurring as customers moving to the Autonomous Database based on what you're seeing in sales that is going now, how that's trending? And any sense of how to think about how large Autonomous Database revenue is, any color would be appreciated?

Our approach sometimes draws criticism from others, but I try to learn from their strategies. Amazon was the pioneer in cloud technology, and I acknowledge their achievements. They utilize a land and expand strategy for marketing their products, successfully starting with one project and then advancing to others. This differs significantly from Oracle's past sales methods. With the Autonomous Database, we have embraced a similar land-and-expand approach. We initiate with a small project that showcases the technology's effectiveness, which often leads to additional projects. We have numerous instances where customers have excelled with their initial projects and progressed to multiple others. The potential for growth in this area is immense. The nearly 4,000 trials we added in Q1 highlights our gaining traction and the growing acknowledgment of the Autonomous Database's value in the broader market.

It's brilliant. The reality is that most of our customers have been waiting for us. They haven't brought their critical large and security-conscious workloads to the cloud so far, not even to other vendors. Those vendors are actually struggling in the enterprise with these important workloads. Customers have begun bringing in smaller workloads, starting small, and then their next purchase can be ten times larger with opportunities often being a thousand times bigger. That's what we're beginning to see. How long will it take? I don't know. We're just going with it. Many of these can also be on a pay-as-you-go basis, which makes forecasting difficult. A customer tries it, and suddenly it expands. The opportunity is enormous because many of these workloads cannot move to the cloud through other means. Those that have attempted have either been unsuccessful or found it to be too expensive while risking their security. This is a very powerful moment for us. We're not going to exaggerate; we're just going to go along with it. You'll hear from some of these customers at Open World. It's similar to when we first talked about our Engineered Systems, where a customer would start small, maybe try one a quarter, and soon have dozens as they grow. Now, this is the next level for those critical workloads that can only function in our cloud.

Next question, please.

Hey, I want to extend my thoughts and prayers to Mark and his family. I have two quick questions. First, regarding deferred revenue, it should be increasing, so can you explain why it declined this quarter? Secondly, I want to discuss ERP. Larry, you mentioned that some medium-sized SAP customers are beginning to explore options. Is the challenge in scaling up more about functionality and capabilities or is it about referenceability? Looking at your recent performance, you managed to close the quarter in just 11 to 12 days, which is a record I’ve seen. You’re utilizing Oracle Fusion, which appears to be a strong solution. So I’m curious about what might be holding things back at this stage. Thank you.

I want to thank you for recognizing the impressive close we achieved on Fusion Financials. The team is quite pleased with this result, and we believe all our customers should be able to experience similar success. Yes, this was a rapid close, and we have both the technology and the people to make it happen. Regarding your comment on deferred revenue, I want to clarify that gross deferred revenue is up 3%. However, we have to account for various factors that are primarily timing-related concerning collections. Thus, that's the main takeaway. You shouldn’t expect anything unusual next quarter; it's just about when we make certain payments, which affects the operating cash flow. In terms of deferred revenue, it's really about the timing of collections. There is a slight impact from currency, but the gross deferred revenue figure is indeed up 3%. It's just been adjusted down, and it revolves around the timing of our collections, so there’s nothing significant to worry about here.

The question about SAP is what our major SAP customers are waiting for before they decide to transition to Oracle. It has been quite interesting. I've spent a significant amount of time in Germany speaking with some customers, and they are eager to make the move. I've had conversations with several very large clients who expressed their desire to migrate to the cloud and utilize Fusion. The challenge is that migrating to another SAP system is costly, with some facing migration bills of $1 billion for the necessary upgrades and consultants. The upgrade to HANA, referred to as S/4HANA in the cloud, is substantial, although it does not fully meet the expectations of being a cloud solution.

And for no benefit.

The code remains essentially the same as before. Customers are eager to proceed, but they are waiting for a major client who has already made the transition, as they are hesitant about being the first movers. Many of these larger customers are conservative and prefer not to take the lead. We are currently working with one of their largest clients to transition them to Fusion. Once we can publicly discuss this and use it as a reference — which may take around six months, but could be sooner — they will be close to going live, with several divisions already on Fusion. Almost every business leader I've spoken to in Germany is keen on making the switch, but they need reassurance that it will be successful. We have secured some deals in both high and mid-market segments against SAP incumbents and are actively working on their conversion. If we can accelerate their transition and get them operational faster, we could also onboard one of the largest enterprises on the planet. As we accumulate these references, we believe that customers want to adopt modern technology and migrate to the cloud, which they can achieve with Fusion, unlike with SAP. We see this as a significant opportunity, but we need a solid foundation of references for these larger companies to commit.

Okay. Thank you. That's very clear.

Thank you, Larry. A telephonic replay of this conference call would be available for 24 hours. Dial-in information can be found in the press release issued earlier today. Please call the Investor Relations department with any follow-up questions from this call. We look forward to speaking with you. Thank you for joining us today on short notice. And with that, I'll turn the call back to Holly for closing.