Oracle Q3 Results: A Lot to Like...

Long-time readers know I'm no Oracle apologist. When they've disappointed or, in my view, misled the market I've told you so. But as a sometime Oracle shareholder that's followed the company for more than a decade as an industry analyst, I have to hand it to them for a solid quarter. Perhaps more importantly, this marks the third time in four quarters whereby they've under promised and over delivered (with last Q's disappointment thrown in as ballast).

After the close tonight, Oracle reported solid Q3 results.

You can read the results for yourself, but here are some of the headline numbers:

• Total Revenues
  • Total revenues = $4.41B [27% YOY]
  • New software license = $1.39B [27% YOY]
  • Software license updates and support = $2.11B [24% YOY]
  • Services = $916mm [36%]
• Applications
  • New software license = $423mm [57% YOY]
  • Excluding acquisitions [i.e., i-flex, Portal, Metasolv, SPL] = $389mm [44% YOY]
  • Excluding Siebel [which just anniversaried], growth was 32% YOY
• Database & Middleware
  
  • New database software license = $967mm [17% YOY]
• Margins, Balance Sheet & Cash Flow
  • Operating Income
    • GAAP = $1.39B [32% of revenues]
    • Non GAAP = $1.76B [39% of revenues]
  • Net Income
    • GAAP = $1.03B [23% of revenues]
    • Non GAAP = $1.30B [29% of revenues]
  • EPS
    • GAAP = $0.20 [36% YOY growth, benefited by lower tax rate]
    • Non GAAP = $0.25 [31% YOY growth]
  • Deferred Revenues = $3.04B
  • GAAP Operating Cash Flow [Trailing 4 Qs] = $4.98B
  • Free Cash Flow [Trailing 4 Qs] = $4.73B

Key Takeaways

• So much for mega deals...there were lots of rumors and innuendo floating around that Oracle had closed a series of mega-deals upwards of $50mm-$100mm; which is how they managed to meet expectations. Safra threw cold water on those flames:

Safra Catz: I know there are rumors of mega-deals in the quarter, a couple at over $100 million, and those rumors are simply not true. Even if you added up the top five deals in the quarter, you do not get to $100 million in new license revenue. You add the top 20, you do not get to $200 million.

• You can't credit acquisitions for masking a lack of organic growth this quarter...as the numbers suggest, applications growth was strong any way you slice the data; and Ellison and Chuck Phillips were more than happy to compare their Q3 and TTM license growth to SAP's:

Larry Ellison: We closed the gap and gained applications market share again this quarter. Oracle's application new license business grew 57% in Q3. SAP grew only 7% in their most recent quarter. 57% growth for Oracle, 7% growth for SAP.

Oracle grew its application new license business on average 61% over the last four quarters. SAP averaged only 10% growth over its last four quarters. So in the trailing 12 months, we are growing six times faster than SAP. SAP is still larger than Oracle in the applications business but we are gaining on them consistently and rapidly.

• Guidance was conservative, but body language was unmistakably bullish...Oracle's Q4 guidance calls for 5%-15% new license revenue growth; a far cry from the results delivered in Q3. But let's not forget that Oracle delivered a monster Q4-06 and is up against tough comps. While official guidance may be labeled as "conservative" by some, look at the comments from Safra during the Q&A to get a real glimpse at their expectations:

Safra Catz: Obviously pipelines are very big. We had a huge Q4 last year but obviously the pipelines this year are bigger, significantly bigger. We have assumed modestly lower close rates than we had last year, just always trying to be cautious even though the truth was last year’s close rates were not outrageously high or anything like that, or one or the other. The reality is pipelines are very, very big.

But pipelines do not tell the whole story and we are going to have to close just an enormous amount of business. North America alone, rounding around about $1 billion of new license sales just in the 50 states and Canada. That is a lot of new license revenue to sell but we are very, very upbeat. We have the pipeline supported and then some and we have used very reasonably conservative close rates.

• The pressure is on SAP and BEA to deliver...Both SAP and BEA have to deliver pristine, clean quarters in order to assuage growing concern that Oracle's consolidation strategy is starting to work. SAP, in particular, has a lot to prove as they come off a disappointing Q4 that already saw them reduce expectations for 2007.

• Oracle Enterprise Linux is off to a slow start...Chuck Phillips tried to paint Oracle's Enterprise Linux in a positive light, but there's little question it's off to a slow start. Yes, they announced Yahoo! as a replacement win versus Red Hat; but Ellison chooses his words carefully and the following quote tells that tale:

Larry Ellison: And Oracle has replaced Red Hat at Yahoo! and numerous other customer sites as their support supplier, Linux support supplier. That's extremely important. And this is just the beginning. We're not going to build the Linux business overnight, but we will build it.

• More vertical M&A is on the horizon...Oracle has spent a lot of money building out vertical expertise in financial services [i-flex], communications [Portal, Net4Call, HotSip, Metasolv], and retail [Retek, ProfitLogic, 360 Commerce, Demantra] and, most recently utilities [SPL WorldGroup]; and we shouldn't expect this strategy to change anytime soon:

Chuck Phillips: The second -- your second question considering that our existing verticals are doing so well, are we tempted to do more? The answer is, of course, yes.

Finally: Correcting the Inevitable Non-Sequiturs

What would an Oracle conference call be without a few non-sequiturs to dispel? Larry, Safra and Chuck just can't resist even in quarters that should speak for themselves.

• The irony of organic growth -- Oracle's has been unapologetic about it's aggressive M&A strategy to fuel growth in the apps business; which is why the following pontification from Larry rings so hollow.

[When asked about the key drivers for Oracle's strong middleware growth rate]...

We thought the right strategy was to take all of our middleware components and have a modern integrated suite, all the pieces play together and all of them support industry standards. In terms of a portal, there are industry standards in the portal. BEA went out and bought Plumtree, which was a leading portal supplier but that product did not conform to industry standards. It was not a standards-based product.

We decided to focus on two things: all the pieces fit together, an integrated suite, and industry standards and we think that is playing very well. IBM’s long list of stuff, again, it is not really integrated. A lot of it is standards-based but the pieces do not play together.

Clearly what's good for the goose [middleware] is not good for the gander [apps].

• The irony of "multiple" product suites -- Oracle has a right to put some pressure on SAP; they are fierce competitors with very different strategies. But how can a company that's currently servicing installed bases for Siebel, Peoplesoft, J.D. Edwards, Retek and it's legacy Oracle ERP products have the audacity to accuse SAP of the following:

Larry Ellison: SAP’s growth strategy is to expand into ERP for smaller, mid-sized companies with their new A1F product. I think that is SAP’s fourth product line. They have the product line that they bought for very, very small companies when they acquired [inaudible] company. They have R3, they have mySAP, and now they have A1F, so SAP’s strategy seems to be to have lots and lots of different ERP systems.

Our strategy, by the way, in contrast is with Fusion to have one ERP system, one suite that will be available on demand, that will be available for small and mid-sized companies all the way to the largest company, so a very different strategy.

That is RICH.

• On buying "market leaders" -- During the Q&A, Chuck said:

The answer is of course yes, with the explanation that we really tend to buy industry leaders, leading companies. When we bought i-flex, they are the number one company for automating retail, so we like to buy category leaders when we go into this business.

Let's be clear, some Oracle acquisitions have indeed been market leaders, but that has not been an unyielding prerequisite. Was Portal best-in-class? Was Metasolv? Was 360 Commerce?

Concluding Thoughts

Oracle has been put in the penalty box for a long time because it has chosen to fuel growth via acquisitions. All things being equal, there is a legitimate case to be made for organic growth trumping acquired growth. But if you believe the enterprise software market is maturing, Oracle's approach starts to make sense. The critical component toward M&A-driven growth is an ability to generate shareholder value. Many times M&A comes at the expense of current shareholders as it robs us of current and future cash flow. It also usually involves dilution in the form of increased share count, and hurts GAAP results due to amortization of intangibles. While Oracle certainly has to deal with amortization of intangibles, why aren't they being given credit for actually REDUCING share count year over year? How many technology companies can make that claim? How many tech companies, particularly of Oracle's size, are generating free cash flow in excess of net income? And it's not as though Oracle is doing this on razor thin margins; they've got the best margin profile this side of Microsoft.

As long as the cost of capital remains low and we're seeing LBOs each and every day as private equity firms take advantage of this situation, maybe we should be asking ourselves why more technology bellwethers aren't using leverage to fuel growth versus penalizing Oracle for it.

Related Posts:

• SeekingAlpha Oracle Conference Call Transcript
• Eric Savitz [Barrons]: Oracle Q3 Results
• Anshu Sharma: Oracle continues to grow, beat estimates
• Larry Dignan: Oracle's 3Q impresses

Note: This is not a recommendation to buy or sell Oracle or any other security, but is merely a personal analysis to foster discussion for informational purposes only. At the time of this writing, I and/or funds I maintain discretionary control over, maintained long equity positions in MSFT, SAP and YHOO but did not maintain a position (long or short) in BEAS, IBM, ORCL or RHT.

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Comments

[Thomas Otter]

Jason
Normally I find Oracle's numbers opaque. Thanks for the clarity. It was a good Quarter for them, Larry quotes not withstanding.
Thomas

[Jason C]

One thing to consider on the organic growth front is whether Safra's two statements regarding growth excluding acquisitions are independant or additive.

Here's what I mean. If the statements are additive, it means that excluding several small acquisitions growth for the quarter was 44% on $389 million. And if you further exclude Siebel's contributions from last year* and this year, organic growth for the quarter was 32%. This would mean Siebel contributed about $62 million in the quarter and that business is a shell of its former self.

Alternatively, if the two statements are independent it means excluding several small acquisitions = 44% growth, OR excluding just Siebel (from last year* and this year) = 32% growth. It's an important distinction, because in this case in means that Siebel contributed about $95 million in license revenue, and organic growth was around 18% - still respectable, but not leaps and bounds ahead of the competition.

* You may recall Oracle did share last year that Siebel contributed $21 million in license revenue for the quarter.