Oracle Corp (ORCL) — Q3 2023 Earnings Call Transcript

Thank you, Emma. Good afternoon, everyone, and welcome to Oracle's third quarter fiscal year 2023 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. Additionally, a list of many customers who purchased Oracle Cloud Services or went live on Oracle Cloud recently will be available from the 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 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 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 good afternoon, everyone. Q3 represented another great quarter with continued momentum on the top and bottom line. But before I get to the numbers, I want to share with you a few thoughts that explain what's behind our continued financial success. First, our cloud offerings drive operational efficiency. In fact, one of our competitors recently coined the term, the Oracle playbook, which I absolutely love, because the Oracle playbook is all about doing more while spending less. As you all know, we started this ourselves over 20 years ago and have kept it up over all these years, resulting in the highest margins in the software business for decades. Using our own products and services enables us to increase our investments for growth, while also growing profitability, including through acquisitions as well as during our move to the cloud. We are constantly talking with our customers about leveraging Oracle technology to accelerate their speed to market and reduce cost, all the while improving the experience they deliver to their customers. The combination of Oracle's infrastructure and apps, which is unique in the cloud market, increases the intensity of business transformation. Cloud is no longer about just renting commodity white boxes. It's about velocity and value. We have become the enterprise technology vendor of choice because we have products and services that help our customers drive cost efficiencies and modernize their businesses. Second, while AI has been dominating the recent news cycle, the truth is that our Fusion and Infrastructure customers have been using AI as an integral part of their business for some time. Oracle Fusion, with embedded AI, enables customers to close their books in days, not weeks. Oracle AI provides more relevant sales leads. Oracle AI increases infrastructure performance and security with no human intervention. And customers using OCI get AI as a service to help drive their own business transformation. Given our scale and our information advantage across industries and technologies, we are constantly training our applications to do more for our customers, whether it's further what our customers get when they use our platform. And on our Gen 2 OCI platform, the architecture and unique network capability has fast become the platform of choice for many AI companies because OCI runs workloads faster. And time is money in the cloud. So coming to us saves our customers money. Third, customers are putting Oracle's comprehensive and powerful ways to accelerate their businesses. The Uber win was notable because we have yet another example of an industry-transforming company concluding that Oracle's cloud, performance and security exceeds that of our competitors and at a price point that represents a sustainable long-term partnership. Uber will use more of our technology to drive value in their own business. And you're going to see a rising list of these types of strategic wins pile up in the quarters to come. Finally, before I move to the numbers, and hopefully, no one missed this fact, we're announcing our earnings nine days after the close of the quarter, and we expect to file the Q right away. We continue to set the standard in operating efficiency which helps customers see what's possible when they are working with us. Okay. Now to the Q3 results. As always, I'll discuss them using constant currency growth rate to provide a full picture both organically and otherwise, I'm going to go over the revenue results, including Cerner, and then some revenue results excluding Cerner. Total cloud revenue, that's SaaS plus IaaS, including Cerner, was $4.1 billion, up 48% in constant currency, with IaaS revenue of $1.2 billion, up 57% and SaaS revenue of $2.9 billion, up 44%. Now excluding Cerner, total cloud revenue was up 28% in constant currency at $3.5 billion. Total cloud services and license support revenue for the quarter, including Cerner, was $8.9 billion, up 20% in constant currency, driven again by our strategic cloud applications, autonomous database and our Gen 2 OCI. Application subscription revenues, which includes support, were $4.2 billion and up 33% in constant currency. Infrastructure subscription revenues, also including support, were $4.8 billion, up 10% in constant currency. Application subscription revenues, including support but excluding Cerner, were $3.4 billion, up 8% in constant currency. SaaS cloud revenue, again, excluding Cerner, was $2.3 billion and was up 16%. Our strategic back-office SaaS applications now have an annualized revenue of $6.2 billion and grew 25% in constant currency, including Fusion ERP, up against 28% and NetSuite ERP, up 26% this quarter. As mentioned already, infrastructure cloud services revenue was up 57% in constant currency. And when you exclude our legacy hosting services, infrastructure cloud services revenue grew 65%, with an annualized revenue of $4.4 billion, including OCI consumption revenue, which was up 86%, cloud customer consumption revenue, up 73%, and autonomous database, up 50%. Database subscription revenues, which include database support, were up 3% in constant currency, highlighted by cloud database services, which were up 40%. Database's subscription revenue is largely made up of on-premise database support. But as these databases migrate from on-premise to the cloud and cloud customer, we expect these cloud database services will be the third leg of revenue growth alongside back-office SaaS and Gen 2 OCI cloud services. Software license revenue, including Cerner, were $1.3 billion, up 4% in constant currency. So all in, total revenues for the quarter were $12.4 billion, up 21% in constant currency. Excluding Cerner's contribution of $1.5 billion, organic revenue was up 7% in constant currency. As a reminder, we no longer operate in Russia, causing organic revenue growth to be negatively affected by 1% of growth over last year. Shifting to margins. The gross margin for cloud services and license support was 79% as a result of the mix between support and cloud. Last year, Oracle license support revenue with its mid-90s gross margins represented about 63% of cloud services and license support revenue. Now because our cloud services are growing so fast, it's down to 55%. Additionally, I would note that IaaS gross margins improved substantially from last year, and I expect IaaS gross margins will continue to improve. While we have continued to build data center capacity, we've also seen our margins go higher as these new cloud regions fill up. Most importantly, gross profit dollars of cloud services and license support grew 13% with Cerner and 6% excluding Cerner. Non-GAAP operating income was $5.2 billion, up 11% from last year. The operating margin, including Cerner, was 42% as we continue to integrate Cerner in the quarter. As we drive Cerner profitability to Oracle standards and continue to benefit from economies of scale in the cloud, we will not only continue to grow operating income, but we will also grow the operating margin percentages. For example, while we have only owned Cerner for three quarters, we have already improved its operating margin by over 5 percentage points compared to before the acquisition. And by the way, I actually expect this year, FY 2023, the one we are closing out in one more quarter, will be the trough year for operating margins and percentages as our margin improvement initiatives play out. The non-GAAP tax rate for the quarter was 18.4% and non-GAAP EPS was $1.22 in U.S. dollars, up 8% in USD, up 13% in constant currency. GAAP EPS was $0.68 in U.S. dollars. At quarter end, we had nearly $8.8 billion in cash and marketable securities. The short-term deferred revenue balance was $8.6 billion, up 14% in constant currency. Over the last four quarters, operating cash flow was $15.5 billion, and free cash flow was $7.3 billion with capital expenditures of $8.2 billion. Operating cash flow for the quarter was up 11% at $4.3 billion. The remaining performance obligation or RPO balance is $62.3 billion, up 66% in constant currency due to strong cloud bookings as well as Cerner, which Larry will discuss in a moment. I will also note that the organic RPO growth rate was 26% in constant currency. Approximately 48% of total RPO is expected to be recognized as revenue over the next 12 months. CapEx this quarter was $2.6 billion as we continue to build capacity for existing bookings and our customers' growing needs. Given the demand you see reflected in the RPO as well as what we see in our pipeline, I expect that our CapEx investments will be about where it is right now for the foreseeable future. As always, we remain careful to pace our investments appropriately and in line with booking trends. We now have 41 public cloud regions around the world with another 8 being built. In addition, 12 of these public cloud regions interconnect with Azure, giving customers true multi-cloud capabilities. We have many cloud customer implementations, 10 dedicated regions and another 9 national security regions with increasing demand for more. As we've said before, we are committed to returning value to our shareholders through technical innovation, strategic acquisitions, stock repurchases, prudent use of debt, and a dividend. This quarter, we repurchased 1.8 million shares for a total of $150 million. In addition, we paid out dividends of $863 million in the quarter. And the Board of Directors increased the quarterly dividend 25% from $0.32 to $0.40 per share. Our financial strategy remains focused on growing non-GAAP operating and pre-tax income while substantially increasing cloud revenue growth. And given increasing customer interest in our cloud technologies, we will continue to prudently invest to meet this demand. As a reminder, because now we're going to talk about Q4, last Q4, we had a spectacular double-digit revenue growth rate, highlighted by 25% constant currency growth in software license. With our continued migration to the cloud, we expect that we will continue to win big deals that are more subscription-driven than license-driven. These big subscription wins add to the backlog and are recognized over time rather than upfront. That is exactly what we want to see as our cloud business continues to see excellent growth. So now let me turn to my guidance for Q4, which I'll provide on a non-GAAP basis. Now assuming the currency exchange rates remain the same as they are now, currency would have a 2% negative effect on total revenue and at least a 3% plus negative effect on EPS in Q4. But as I say every quarter, the actual currency impact may be very different by quarter end. Okay. Here we go. Total revenues for Q4, including Cerner, are expected to grow from 17% to 19% in constant currency, and thus are expected to grow 15% to 17% in USD. Total cloud growth, including Cerner, is expected to grow from 51% to 53% in constant currency, 49% to 51% in USD. I expect total cloud growth for Q4, excluding Cerner, will be above 30% in constant currency. I expect growth in operating profit to be double digits. As you all know, my non-GAAP tax rate guidance is typically 20.5%. However, our tax rates over the last two years and Q4 have averaged around 11%, and I anticipate that in Q4, the most likely outcome is a non-GAAP tax rate of around 14.5%. And we've used this rate in determining our EPS guidance for Q4. Now mind you, that's comparing it to 11% or 10.5%, I think, last year. Regardless, like past quarters, the actual tax rate for Q4 could be higher or lower and affect our actual EPS. With that, non-GAAP EPS is expected to grow between 3% and 5% and between $1.59 and $1.63 in constant currency. Non-GAAP EPS is expected to grow between 1% and 3% and be between $1.56 and $1.60 in USD. What have I got here? Anyway, as I've said before, Cerner will be accretive to earnings this year, including Q4. And with that, I'll turn it over to Larry for his comments.

Thank you, Safra. Since acquiring Cerner in June of last year, the business has expanded its healthcare contract base by about $5 billion. We have secured a variety of new and growing domestic and international clients, including the U.S. Department of Defense, the U.S. Department of Veterans Affairs, hospital groups across numerous states in the U.S., several hospitals in the UK, various provinces in Canada, the Australian Defence Forces, multiple hospitals in Puerto Rico, and several countries in the Middle East. We are encouraged by this early success and anticipate that the rate of signing new healthcare contracts will increase in the upcoming quarters. The Cerner business has been securing billions in orders for Millennium Clinical and electronic health record systems to serve hundreds of hospitals and ambulatory clinics. The overall Oracle Healthcare application portfolio is comprehensive, addressing nearly the entire healthcare ecosystem. Hospitals are adopting the Oracle Fusion ERP system for managing their revenue cycles, which includes processing reimbursements from insurance companies and patient billing, as well as managing their medical supply chains from ordering to inventory. Hospitals are also implementing Fusion HCM to handle their complex workforce consisting of doctors, nurses, and technicians. Pharmaceutical companies are utilizing Oracle Clinical One for managing clinical trials. Additionally, government and public health organizations are leveraging aggregated EHR data to monitor infectious diseases and respond to outbreaks more effectively. Now I'd like to highlight some significant Cerner achievements since our acquisition. One notable accomplishment is our collaboration with Labcorp and Ascension Health to implement a unified lab information system for 96 hospital-based labs across 10 states. In Puerto Rico, Auxilio Mutuo is adopting a new electronic health record system to serve a 600-plus bed academic private hospital, replacing Altera and Paragon with Cerner Millennium. Vandalia Health has consolidated all their EMRs into a single unified system and added four new hospitals. UHS has modernized their revenue cycle and transitioned to CareAware Cloud for their hospitals and clinics. Banner Health has implemented a comprehensive revenue cycle management system for their operations. The VA has rolled out our unified electronic health record system to an additional 19 locations. The Department of Defense has deployed Oracle Cerner EHR across all OCONUS sites. In the UK, Sheffield Teaching Hospital within the National Health Service has extended Cerner applications across three more sites. The Princess Alexandra Hospital, also part of the NHS, has added the full Cerner suite to its 430-bed facility. Mubadala Health became the first Cerner Millennium client to transition directly from the Cerner data center to the OCI Cloud. As we migrate our Cerner patients to the Oracle OCI Cloud, we anticipate improvements in security, reliability, performance, and a significant reduction in costs for cloud services. OCI offers much greater efficiency compared to the Cerner data centers we acquired. We have deployed the full Cerner EHR framework to four Sheikh Khalifa Hospitals in the U.A.E., which collectively have a capacity of 1,200 beds and serve a population of 1.4 million. For the Australian Department of Defense, we delivered acute care capabilities and established a supportive environment for all Australian Defence hospitals and field hospitals. In Canada, starting in Nova Scotia, we implemented a one-patient, one-record EHR system across the province, resolving the issue of scattered patient electronic health records. This same initiative is being implemented in Niagara Health to support the care of 450,000 citizens in Canada. These represent direct wins for Cerner since our acquisition. Additionally, we offer a full healthcare suite made up of Oracle ERP, Oracle HCM, and Oracle Clinical One for clinical trials, which manage all aspects including procurement, inventory, and workforce scheduling. We have notable customers such as the Cleveland Clinic using our ERP system, the Mayo Clinic, Mount Sinai Hospital, and Providence St. Joseph Health, all utilizing our various solutions to manage their healthcare operations. Recently, we achieved significant wins at Ascension Health, which purchased ERP and HCM solutions, where the primary competitor in HCM was Workday. Our enhancements for healthcare workforce management in our HCM product are increasing our success in selling within the healthcare ecosystem. This has resulted in improved win rates and shortened sales cycles. The University of Texas Health in San Antonio was a significant HCM win, and Labcorp purchased ERP and HCM, competing against SAP. We also secured BlueRock Therapeutics, which opted for ERP, SCM, and Fusion Analytic Warehouse, also beating SAP in the process. We had major go-lives last quarter, with Providence Health expanding to 12 additional ministries and all Trust hospitals in the UK now live with ERP. Baptist Healthcare now has 10,000 employees using HCM, and Texas Children's Hospital has 21,000 employees live on HCM. Kelsey-Seybold Clinics are now fully operational with HCM. I could continue, but I’ll hand it back over to Safra.

Thank you, Larry. Emma, if you could please poll the audience for questions?

Given the slowdown across many IaaS and PaaS vendors in recent quarters, particularly this quarter, what has contributed to the resilience of OCI Gen 2? You have customers who were born in the cloud, experiencing weakness in other areas, as well as enterprises. Is it just a matter of competitive pricing? Is it performance-related? Are you benefiting from the timing in the economic cycle to attract new customers? Are there dynamics concerning expiry credits influencing this? The contrast is significant, and it's crucial to understand. Any additional insights you can provide would be appreciated.

I’d like to address that. I'll begin by discussing my recent conversation with Jensen at NVIDIA. Oracle's Gen 2 Cloud stands apart from other hyperscalers because we utilize a non-blocking RDMA network, which is significantly faster than those of our competitors. This speed enables us to create dynamic clusters of NVIDIA GPUs for large-scale AI tasks. While others can build clusters, they do so by physically constructing new hardware. In contrast, our existing standard network allows for the dynamic grouping of GPUs to tackle AI challenges. As a result, we are attracting numerous new AI companies to Oracle since we can efficiently run their workloads, and we do it at a lower cost. For instance, we have a collaboration with MD Anderson Hospital and the software vendor Ronan, developing AI modules that guide doctors on patient care. MD Anderson has demonstrated that using this system can reduce hospital admissions and readmissions by 30%. This is a remarkable achievement. While some may find generative models like ChatGPT impressive, what we're doing to lower hospital readmissions is arguably more significant. Our focus on AI in healthcare has intensified following the acquisition of Cerner, and we are dedicated to applying AI to manage complex diseases such as cancer, as well as other health issues like wellness and heart disease in the future. Our platform is optimized for running AI effectively by forming GPU clusters to solve substantial problems rapidly and efficiently, which we then build applications upon to support many startups in the AI space. This demonstrates our clear lead over other hyperscalers in terms of our network capabilities and AI execution.

Thank you, Larry. My question was very much related to that, but maybe from a slightly different angle. I'm wondering if you could drill into the opportunity that you do see on the generative AI side? We're repeatedly hearing that companies are running those kinds of models on OCI. NVIDIA is moving some of those workloads to the Oracle Cloud. And the other concept being that these AI models are so data-hungry and that you have all the data already contained in the Fusion applications. I am curious if that piece of it, the generative AI piece, is something that you see lining up as a growth driver that is material overall on the entire business.

The answer is absolutely yes. There is actually more demand for AI processing than there is available capacity, and we are the only ones that can dynamically expand, although we are short. We are growing as fast as we can. It's an exciting opportunity, but it is challenging when demand exceeds supply. The key difference with us is that our standard network allows us to group GPUs together to tackle various problems, whether they are related to medical diagnostics or generative language tasks like ChatGPT. We have numerous independent software vendors looking for our services because we offer the most cost-effective solution and can provide it to them quickly due to our standard network. We can create a cluster for them to run their workload, and once their workload is complete, we can reallocate or break up that cluster to serve other users. Other providers cannot offer this dynamic capability.

Thanks for taking my question and I'll echo my congratulations, especially on sustaining very high OCI growth. Larry, one area we've been doing more work on is how cloud vendors can help transform the telco market, including migrating their IT infrastructure and their network operations to the public cloud, which should lead to greater efficiencies and also give them a more effective platform to roll out new 5G and edge application services. I know you guys touched on this a bit at last year's Analyst Day, but I was just hoping to get an update on how you're thinking about that telco opportunity with the Oracle Stack, especially with OCI? Who's some of the telco operators you're partnering with? And how you see this playing out over the next couple of years?

This is an exciting opportunity for us as we are building dedicated data centers for Vodafone. Currently, Vodafone is migrating a significant part of their operations to the Oracle Cloud. We have the capability to create data centers tailored for customers, specifically designed for their individual workloads. An example is Nomura, for whom we constructed our first such data center in Japan a few years ago. They have both a primary and a backup data center that manage the Tokyo Stock Exchange and provide services to the financial sector in Japan. Our collaboration with Vodafone mirrors this model, as we are developing dedicated OCI data centers for them as well. These data centers are automated and function similarly to our other OCI facilities, allowing us to leverage economies of scale and skilled personnel to operate them. DISH Network's foray into telecommunications has similarly benefited from our architectural approach using OCI. The telecommunications sector is a key focus for us, and we anticipate significant growth in this area as telcos transition to the cloud. We're observing major commitments from some of our largest global clients. Conversely, financial services companies are approaching cloud adoption differently, often preferring to keep their operations on-premise. However, we can create a dedicated OCI region for banks, as we've done with Nomura, allowing us to establish specialized clouds for financial institutions. This is crucial as these industries transition to the cloud, but in a manner distinct from others, preferring dedicated regions for their specific applications. We possess the capability to provide this service, unlike Amazon, Microsoft, or Google.

I think this question is for Safra. We've heard a lot about your committed cloud mega deals, but you sometimes have talked about pure consumption or pay-as-you-go deals. Other vendors that employ the pay-as-you-go model, such as Mongo and even Snowflake, to some extent, who had been getting a ton of traction in the market, have either seen or they anticipate dramatic slowdowns. We haven't seen anything like that in your results at all and certainly not in your guidance. But can you talk about your exposure to such deals and how they're progressing?

So as Larry was touching on it, we have many, many enterprise customers, phone companies, banks, governments who make commitments to us as part of their move to cloud. So we do have some pay-as-you-go customers, but the bulk of our revenue, first of all, our SaaS revenue, as you know, you implement an accounting system, you're not going to pay less tomorrow. You still have to run your accounting system. So the SaaS side of the business, again, is fully committed. And then because we have so many important enterprise customers who are bringing basically their crown jewels into our cloud and had been waiting really for us to be in the position to receive those, they want to have a two-way commitment. They want to know that we have the capacity for them, and they want to get a slightly better price. So first of all, those that go into the public cloud, whether it's Telecom Italia or Verizon or some of these others, they obviously would like a better price, so they make commitments to come in, usually committing less than they expect to use, and almost always, over using more than they expected. However, other customers have cloud customers, as Larry mentioned, or other different arrangements, the alloy arrangement where we have a combination with the telco or a data center provider, those are all committed. And so we're very strong in the commitments from our customers. And by the way, they want to make sure we have available capacity back for them because many of them get rid of their data centers when they're finished. And that's the ultimate goal for them. They don't want to be running back and forth. These aren't toy workloads. These are critical workloads for their business, and they want to know that they've got a place to put those.

So the commitment is that many of these people are dedicated to ramping up to the full capacity of their data center, and they will not shut down their existing data centers until they achieve that.

Yes.

Okay.

Yes. Just so that we're clear here. Pay-as-you-go at Oracle is less than 5% of our business. Okay?

Okay. That's very clear. Thank you very much, Safra.

Thank you, Brad and Safra. A telephonic replay of this conference call will be available for 24 hours on our Investor Relations website. Thank you for joining us today. And with that, I'll turn the call back to Emma for closing.