Oracle Corp (ORCL) — Q3 2020 Earnings Call Transcript

Thank you. Good afternoon, everyone, and welcome to Oracle's Third 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 our 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 being made today. As a result, we caution you against placing undue reliance on these forward-looking statements, and we encourage you to review our most recent reports, including our 10-K and 10-Q and any applicable amendments, for a complete discussion of these factors and other risks that may affect our future results or the market price of our stock. And finally, we are not obligating ourselves to revise our results or publicly release any revision of 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. As usual, I'll review our non-GAAP results using constant dollar growth rates unless I state otherwise. As you can see, we had an excellent quarter in Q3 with total revenue growth of 3% in constant currency and EPS of $0.97 in U.S. dollars. Both revenue and EPS were above the midpoint of my guidance even though we saw a strengthening U.S. dollar, which resulted in a negative headwind to total revenue. It was really a remarkable quarter with a lot of product and customer momentum in both applications and infrastructure. The quarter demonstrated the acceleration of revenue that I've been forecasting. Our Cloud Services and License Support business, basically our subscription business, which includes SaaS, IaaS and software updates, powered our revenue growth. Those subscription revenues for the quarter were $6.9 billion, up 5% and accounted for nearly 71% of total company revenues, up from 69% last year. License revenues were $1.2 billion, the same as last year. We are seeing a lot of momentum across our applications portfolio, with GAAP application subscription revenues at $2.8 billion, up 7%. Fusion apps were up 32%, Fusion ERP was up 38% and Fusion HCM was up 27%. NetSuite ERP was up 26%. Vertical SaaS was up high single digits, and data cloud was up low single digits. GAAP infrastructure subscription revenues were $4.1 billion, up 4% with total database revenue up 5%, highlighted by BYOL and Autonomous Database revenues both up over 150% but off a small base. As you can see, we've replaced ecosystem revenues with subscription revenues, which will make it easier for you to see the revenue growth rate of the largest part of our business more clearly. You'll still be able to determine the growth rates for our entire software ecosystem by combining subscription and license revenues. Our cloud renewal rates continue to go up. The gross margin for Cloud Services and License Support was 86%, up 1% from last quarter. Both SaaS and IaaS gross margins were up more than 1% from both last quarter and last year. As we continue to get to scale, I expect our cloud gross margins will increase further, driving an acceleration in our gross profit growth. Total revenues for the quarter were $9.8 billion, up 3% from last year. Non-GAAP operating income was $4.4 billion, up 3% from last year. The operating margin was 44%, essentially unchanged from last year. The non-GAAP tax rate for the quarter was at 19.1%, slightly below our base tax rate of 20%. EPS was $0.97 in U.S. dollars, up 12% in constant currency and 11% in USD. The GAAP tax rate was 16.4% and GAAP EPS was $0.79 in USD, up 5% in constant currency, 4% in USD. Operating cash flow over the last 4 quarters was $13.9 billion. Capital expenditures were $1.5 billion and free cash flow was $12.4 billion. We now have approximately $26 billion in cash and marketable securities, and the short-term net deferred revenue balance is $7.8 billion, down 1% in constant currency due to timing differences in customer payments. Gross deferred revenue was up over 1% in constant currency and would have been up over 3%, if not for the ASC 606 transition changes. Now we remain committed to returning value to our shareholders through technical innovation, strategic acquisitions, stock repurchases, prudent use of debt and the dividend. This quarter, we repurchased 73.5 million shares for a total of $4 billion. And over the last 12 months, we have repurchased 366 million shares for a total of $20 billion. And over the last 5 years, we have reduced the shares outstanding by nearly 28%. The Board again declared a quarterly dividend of $0.24 per share. The Board of Directors also authorized an additional $15 billion for the repurchase of Oracle shares. Now before turning to guidance, I need to say a few words about the impact of the COVID-19 virus. Over the last few weeks, we've observed the growing public concern. We're largely conducting business as usual with some modifications such as using video conferencing and asking our employees to postpone nonessential travel. Likewise, we're seeing other companies take precautionary actions. It's not yet clear what the effect the virus will have on our customers and suppliers and, as a result, what the impact will be on our business in Q4. So with that backdrop, let me share with you my thinking on the modeling for Q4. The subscription part of our business, cloud and product update, will continue to grow, and we expect minimal impact from the virus in the quarter, given that much of the subscription revenue is already contracted. Last year, the subscription business was 61% of the quarter. Consistent with the trends over the last year, I expect it to be a larger percentage of Q4 this year. In meeting with my executive team, we reviewed the enormous pipeline of transactional business for Q4. As you know, Q4 is typically a seasonally large quarter for software licenses and, to a lesser extent, hardware. Given the uncertainty in the current business climate, I am going to provide a much wider range in my estimate for total revenue. My guidance today is on a non-GAAP basis and in constant currency. Assuming current exchange rates remain the same as they are now, currency should have no significant effect on revenues or EPS. Now, of course, that may change, but that's what it is right now. So for Q4, total subscription revenues are expected to range between 3% to 5% in both constant currency and U.S. dollars. Total revenues are expected to range between negative 2% to positive 2% in both constant currency and U.S. dollars. Non-GAAP EPS is expected to grow between 3% to 9% and be between $1.20 and $1.28 in both constant currency and USD. Total CapEx for FY '20 is expected to be around $2 billion but it could vary. My EPS guidance for Q4 and the FY '20 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. Now in June, assuming the global economic situation has stabilized, I will share with you the basis for my optimism around our revenue growth acceleration for fiscal year 2021. It will be based on the ever-growing portion of our revenue attributable to our faster-growing subscription business. You saw a bit of it in Q3, and it would have been even more obvious but for the early impact of the virus.

Thank you, Safra. There are two critical product areas that will shape Oracle's future: cloud ERP applications and Autonomous Database infrastructure. Leading in both of these significant market segments will foster the success of our other applications and infrastructure products in related markets. We anticipate that the cloud ERP market will be two to three times larger than the old on-premise ERP software market. We currently have a substantial lead in the cloud ERP market with over 7,000 Fusion ERP customers and 21,000 NetSuite ERP customers. Our main ERP competitors are facing challenges. SAP has not transitioned their ERP applications to the cloud, and as a result, many of SAP's largest clients are working with us to migrate to Fusion ERP. Workday, another competitor, is struggling to gain traction in cloud ERP, holding a small market share compared to ours. Interestingly, Workday's challenges in cloud ERP are also opening up opportunities for Oracle in cloud HCM. HCM is increasingly being offered as part of an ERP Cloud application suite, allowing Oracle to surpass Workday in the number of HCM customers, with Fusion HCM revenue growing at a faster pace than Workday. We're also starting to see our integrated suite strategy boost sales of customer experience applications across sales, service, and marketing. I want to highlight a few of our multi-pillar deals that showcase the strength of our integrated cloud application suite. Johnson Controls signed a $15 million annual recurring deal that included ERP, enterprise performance management, supply chain management, and several CX applications for marketing, service, sales, e-commerce, and Configure, Price, Quote. Skanska similarly purchased Fusion ERP, Fusion EPM, and Fusion HCM, alongside Fusion Supply Chain and HCM in the cloud. We experienced numerous wins in both ERP and EPM in the cloud, including contracts from Unisys for ERP, EPM, SCM, and CX; S&P Global for ERP; United Services Automobile Association for ERP; and RECO for ERP. Furthermore, SCL Health bought both ERP and HCM, while Adecco, the Institute of Electrical and Electronics Engineering, United Airlines, Snap, and CDK Global all made significant ERP purchases. We secured several supply chain wins this quarter, with Dow Chemical and National Oilwell moving to Fusion Supply Chain and other contracts from RECO, Unisys, Citrus World, ConAgra, UC Health, National Convenience Distributors, and Total S.A. We're seeing strong sales of HCM as part of the suite; CSX, UC Health, Nemours, Molina Healthcare, Sensium Technologies, and Ford Motor Company have all expanded their Oracle Fusion HCM Cloud implementations. Keurig Dr Pepper purchased our CX products, and other companies, including IKEA, Micro Focus, Banco de Chile, and Comcast, have also made various purchases within our Fusion suite. Now, shifting to our infrastructure business driven by our database business, Oracle has maintained its leading market share in the database sector. In this quarter, our overall database business, both cloud and on-premise, grew by 5%, with our cloud database segment seeing triple-digit growth. We hold a significant technological advantage with our Autonomous Database and expect our database growth rates to increase beyond the 5% we reported last quarter as customers move from legacy databases to our cloud solutions. Let me share some notable strategic wins that highlight the momentum of our infrastructure business. Nomura in Japan committed $20 million to the Oracle Cloud, migrating their production systems for critical transactions to our cloud. Fiserv made an $8 million commitment to transition their payments applications to Oracle's Gen2 infrastructure for significant cost savings. WorkForce Software also moved their SaaS application to Oracle Gen2 public cloud with a $4 million commitment due to better performance and security compared to their previous data centers. Gap has $6 million annual commitment for Oracle Cloud to migrate their retail applications. Manhattan Associates, T-Mobile, and several others are also moving their systems to our cloud. Notably, the Depository Trust & Clearing Corporation, which manages 98% of global trades, is migrating their sizeable data system from Amazon AWS to our public cloud utilizing the Oracle Autonomous Database and Oracle Analytics suite. Other major companies like Sonoco, National Bank of Canada, and Norfolk Southern are also migrating their operations to Oracle’s cloud solutions. We're witnessing strong demand as customers transition from Microsoft SQL Server, AWS, and Workday to utilize our cloud applications and infrastructure. This quarter has been incredibly successful for us, showcasing significant wins, and now I’ll turn it back to Ken.

Thank you, Larry. Operator, if we could please queue up the audience for questions, please?

I was wondering if you could talk about the rebound you've mentioned that is starting to show up in the numbers, especially concerning your database business. In Q1, you noted some dislocation, and it seems things are starting to move in the direction you've indicated. Can you share any details about what you believe is driving this? Is it related to OCI as well? Additionally, you mentioned that you might have more information to share in May when there is more stability from a macro perspective. Are there any high-level thoughts you're comfortable sharing now about the acceleration you're observing and how we should view it going forward?

Okay. So I will start and then, Larry, you can add what you'd like. Obviously, the power of having great products is what overwhelms everything. And the momentum we have with Autonomous Database and the more and more success, all of these projects start as small projects and expand very dramatically. Our average consumption rate is just increasing dramatically, and it's the result of Autonomous Database being incredibly powerful and very, very popular with our customers. In addition, the database itself, database license, the technology business, which I had mentioned earlier in the year, we had a little reorg in North America, a few things like that, that is really chugging. In fact, it probably would have been even better but for this coronavirus showing up at the end of the quarter. Basically, the last week in February, market was down a lot, and so I expected but for this coronavirus for Q4 to be really impressive. By assuming that we have some stability in the economy globally, I will be sharing with you the fact that it's a bigger and bigger number. That consumption revenue is going way, way up. And that this entire subscription side of the business, the infrastructure subscription side of the business is just getting bigger and grows and grows. So overall, good products, good services lead to success for our customers and then adoption takes care of itself. I don't know, Larry, if you want to add anything to that.

I want to elaborate on what Safra means by great products. The Autonomous Database is truly a distinctive product because it eliminates human labor, which in turn eliminates human error. This results in lower operational costs since the Autonomous Database operates on its own, without the need for human intervention. With no human labor involved, there are no mistakes that could lead to security vulnerabilities. Additionally, the Autonomous Database is both serverless and elastic. This means that when your application isn't active on the Oracle public cloud, you aren't charged for any CPUs, as none are allocated to you during inactive periods. In contrast, with Amazon's databases, you incur costs for their processors even when not in use. Our service is not only serverless, but it is also instantaneously elastic, allowing you to scale from 2 cores to 20 cores in real-time while the database remains operational. When the demand decreases, we automatically revert to 2 cores. This exemplifies the true essence of cloud computing—it's serverless when idle, and fully elastic so you only pay for what you consume. As a result, customers who compare our offering against AWS often find that we are significantly more cost-effective while providing better security and performance. Once they conduct a trial and see the advantages, they choose our services. Notably, some of our clients include various SaaS application providers, whose core business relies on running applications. They have evaluated different cloud options and concluded that we offer the most secure, highest-performing, and cost-effective solution. Consequently, we are increasingly gaining more business, and we anticipate this positive trend to persist.

Larry or Safra, I just wanted to ask a question about the hardware business, which I know isn't typically in focus for most investors, but I know many customers have been anxiously anticipating the availability of Autonomous Database to be supported on Cloud at Customer. So my question is, can you give us any sort of update on the impact that supply constraints might be having on the hardware business? And in any way, can that impact the availability of Autonomous to be shipping on Cloud at Customer?

There was a slight impact in the third quarter due to shortages of certain components. In fact, the third quarter figures would have been higher if not for the supply chain issues affecting both our suppliers and their suppliers, mainly because of the coronavirus situation in China. We are working through these challenges and will assess the availability in the fourth quarter. While we anticipate some ongoing impact, my guidance reflects our capacity to deliver some, but not all, of what we could potentially sell in the fourth quarter.

Yes. I'd like to comment as well. Our Exadata cloud database Cloud at Customer product consists of the same components as traditional servers. As a result, we can shift components from traditional servers to Exadata machines. The Exadata machines are of significantly higher value because they include a larger software component when we sell them, and they represent Gen2 Cloud at Customer. Therefore, if we need to reallocate resources from conventional commodity servers to our Exadata machines, any shortfall is likely to come from the less expensive and less profitable commodity servers rather than the high-value, high-margin Cloud at Customer servers. We are committed to working diligently to fulfill all of those orders.

Congrats on a great Q3. I just wanted to focus in on the apps business. Obviously, Safra, you called out the acceleration there but also some pretty strong growth rates, ERP Cloud, 38%, HCM Cloud Fusion, 27%. So 2 questions here. First, what's actually driving this growth? Is this your existing customers flipping over from on-premise to the cloud? Or is it net new customers to Oracle? And I guess a question for Larry, too. What are you hearing about sort of why customers are choosing you? Or how much is the breadth of your ERP suite impact that buying decision?

Let me answer your question directly. Yes, we are acquiring new customers. Yes, we have customers upgrading from the e-business suite. Yes, we are taking customers from our biggest competitors. Yes, we are replacing some of our SaaS competitors. It includes all of these factors. Now I'll hand it over to Larry. Go ahead.

Yes, this relates back to the maturity of our product and our belief that we have the best technology. Our products are built on a database that is faster and more secure than others, so our applications benefit from those features. Additionally, they leverage technologies like our voice digital assistant. When we demonstrate our product against Workday, which has always claimed to have a superior user interface compared to Oracle, we contest that assertion. Users can simply interact with their smartphones to access reports and perform transactions by voice commands, such as asking, “Oracle, how many vacation days do I have?” and “Oracle, I’d like to schedule a one-week vacation starting August 17.” This modern user interface makes our applications highly accessible, showcasing the technological distinction between us and Workday. Our primary advantage over Workday and SAP is that our applications are built upon our own infrastructure. Unlike us, SAP lacks an infrastructure cloud, and Workday does not have such a cloud, a voice digital assistant, or an autonomous database. They also do not utilize integrated machine learning for fraud detection or security intrusion prevention. Our applications benefit from all these advantages, enabling us to compete effectively against them from demonstration through deployment. Moreover, we possess a very extensive suite of solutions, making it challenging for a company like Workday to develop the full range of offerings from customer experience to human capital management, enterprise resource planning, supply chain, and manufacturing. For smaller firms, this is particularly difficult, and for SAP, it’s even tougher since they haven't begun developing for the cloud. We are succeeding widely in applications, equipped with the most modern technology, superior security, and outstanding performance. We are performing exceptionally well against all our competitors in back-office functions, HCM, and ERP, and we’re making progress against Salesforce, which remains a very strong competitor in the front office. This represents a different competitive landscape.

Can you discuss the current state of Oracle in comparison to 2008 and 2001, particularly in terms of our recurring revenue stream during these uncertain times? Additionally, could you share your insights on renewals related to our database and cloud offerings?

Yes. As I mentioned in my opening remarks, a significant portion of our revenue comes from recurring sources, mainly our support and cloud businesses. This has been steadily increasing year after year, and in the last quarter, it accounted for 71% of our revenue. In the first quarter, it is expected to remain high because there are no large fluctuations. However, the upcoming fourth quarter usually sees the lowest percentage due to a larger transactional business, with last year being at 61%. If this quarter performs similarly to last, I anticipate it will be around 63% at minimum, possibly even higher. We have much less variability now compared to past downturns, like in 2001, when the internet bubble burst and our license revenue, which was a significant part of our business, fell dramatically. Our current business is fundamental to our customers' operations, whether through our SaaS products or our robust database infrastructure. Everything has been organized effectively over the past few months, and we are beginning to see the true strength of our business.

I'd like to share a few thoughts. First, to emphasize what Safra mentioned, our business is no longer simply about one-time licenses. In the last quarter, 71% of our revenue was generated from contracts established prior to the quarter, indicating that we are focusing on ongoing subscriptions. Additionally, our business model has undergone significant changes; we have shifted away from numerous small offices scattered everywhere to a hub model where we operate large offices in Austin and California. We conduct digital selling and support, using online communication for demonstrations and presentations. Implementation consulting is being done from locations like India and the Philippines without on-site visits. Our selling and service delivery are increasingly digital, and a larger portion of our revenue is now generated from subscriptions and recurring sources. Our business has transformed drastically since the Internet bubble, particularly from 2001 and 2008, resulting in a much different landscape today.

Congratulations on the quarter. You increased your buyback authorization this quarter. How should we think about how you will use the buyback given the market downturn? Also, how should we think about your ability to support the dividend, expand the dividend, given the economic downturn? It seems to be a very positive statement you're making. I'd like to get whatever color you can on that.

We can easily support our dividend and any potential increase. Our business remains robust and generates substantial cash flow. While I won’t comment on future buybacks, it is clear that we have been repurchasing our stock, which we consider a great opportunity given recent price drops. It’s an excellent investment that decreases the number of shares we need to distribute our profits among. Our business has clearly reached a turning point, and I noted that we expect acceleration in the latter half of the year. The worldwide response from companies and governments has been unexpected. I've been working on projections for Q4, and if conditions stabilize next year, we anticipate continuing our momentum. Our stock is clearly undervalued, and we are authorized to buy back shares, with updates to come once we proceed.

Nice to see strong results, particularly in a tough time. I want to come back to applications. Applications accelerated in this quarter and Fusion apps continue to grow at high rates. Is there anything left in terms of headwinds that could keep you from seeing further acceleration in app subscription this year and next? And where do you think that growth rate could end up for this year?

The business is fantastic, okay? It's obviously accelerating. The base of the business keeps growing. We are winning, we are winning constantly. The products are getting stronger every quarter, and it really ultimately is well on its way. Larry, I'm sorry, I interrupted you.

In applications, we are engaged with over 10 of SAP's largest customers. We are working with American, Asian, and large German companies to implement Fusion in multiple divisions. One of the companies is looking to replace all of SAP in their operations with Fusion rather than just one division. This trend is surprising; some of SAP's largest clients are considering moving away from them because SAP has not transitioned to the cloud and has not updated their applications. Their code is essentially unchanged from 35 years ago, still using their proprietary programming language, ABAP, while we use Java. This presents a unique opportunity for us to compete aggressively against a leader that faltered in the shift to cloud technology. We are finalizing deals with significant SAP customers and expect to announce that some major clients will be going live on Oracle Fusion applications this summer. We began our collaboration with them 18 months ago, and it reflects a vast opportunity ahead that we believe will significantly boost our applications growth beyond our expectations.

Sure. Thank you. A telephonic replay of this conference call will be available for 24 hours. Dial-in information can be found in the press release issued earlier today. Please call the Investor Relations department for any follow-up questions from this call, and we look forward to speaking with you. With that, let me turn it back to the operator for closing.