Earnings Call Transcript - ORCL Q3 2022

Ken Bond, Senior Vice President

Good afternoon. Thank you for standing by. Welcome to Oracle's Third Quarter 2022 Conference Call. It's now my pleasure to hand today's conference over to Oracle Senior Vice President, Ken Bond. Thank you, Holly. Good afternoon, everyone, and welcome to Oracle's third quarter fiscal year 2022 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 the 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 following this call. 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. However, we will be making no comments regarding Cerner. With that, I'd like to turn the call over to Safra.

Safra Catz, CEO

Thanks, Ken, and good afternoon, everyone. I'd like to start by acknowledging the tragic events unfolding in Eastern Europe as a result of the Russian invasion of Ukraine. We are working incredibly hard to help our Ukrainian employees and support our customers and partners. We have suspended all Oracle operations in Russia, and we did so well over a week ago. I'll now turn to Oracle's third quarter results. I'll review our non-GAAP results using constant dollar growth rates unless I say otherwise. And clearly, we had an excellent quarter with total revenue growing over 7%. Not only was total revenue above the midpoint of my guidance, but it was also the highest organic growth rate since we began our transition to the cloud. We saw broad-based outperformance in all segments. And for the first time in more than 10 years, all segments of our business saw growth. Total cloud revenues, when annualized, are now $11.2 billion, and they grew 26%. I expect the cloud revenue will exit the fiscal year growing in the mid-20s. Total cloud services and license support revenues for the quarter were $7.6 billion, up 8% and accounted for 73% of total company revenue. GAAP application subscription revenues saw record level organic growth of 10% and were $3.2 billion. Fusion apps were up 29%, with strategic back-office applications now having annualized revenue of $5.1 billion and growing 30%, including Fusion ERP, up 35%, and Fusion HCM, up 22%, and NetSuite ERP, up 29%. GAAP infrastructure subscription revenues were $4.5 billion, up 7% and higher than last quarter. And excluding legacy hosting services, infrastructure cloud services grew more than 60%. And I expect the infrastructure revenue growth rate will trend higher over time. OCI consumption, which includes autonomous database, was up 93%, also higher than last quarter. And total Cloud at Customer revenue was up 43%, with the backlog for Cloud at Customer machines growing to triple digits. Database subscription revenues, including database support and database cloud services, were up 4%, and again, higher than last quarter. License revenues were $1.3 billion, up 4%, with strong performance in our tech business. So all in, total revenues for the quarter were $10.5 billion, up over 7%, and as I mentioned earlier, our highest organic growth rate in over 10 years. Operating expenses were up 10% this quarter as we invest to meet growing demand for our cloud services. The gross margins for cloud services and license support was 84%, and the gross profit dollars grew 5%. I expect the full-year growth in gross profit dollars for cloud services and license support will be higher than last year. Our plan is to continue to grow profits while we push our top-line growth into double digits next year. Non-GAAP operating income was $4.8 billion, up 4% from last year. And the operating margin was 46%, higher than all of our competitors. Earnings per share was adversely affected by around $0.05 per share, primarily due to share price declines of equity investments impacted by the widespread downturn in equity markets last quarter. The non-GAAP tax rate for the quarter was 19%, in line with our base tax rate. And earnings per share was $1.13 in U.S. dollars, up 1% in constant currency and down 3% in U.S. dollars. The GAAP tax rate was 18.4%, slightly below our base rate and the GAAP earnings per share was $0.84 in U.S. dollars. Operating cash flow for the last 4 quarters was $10.4 billion, and our free cash flow over the same period was $6.6 billion. Both results were negatively affected by a one-time litigation charge in Q2. Capital expenditures for the last 4 quarters were $3.8 billion, and CapEx for Q3 was $1.1 billion. And we're on track to invest $4 billion in CapEx this year. We now have more than $23 billion in cash and marketable securities. The short-term deferred revenue balance is $7.9 billion, up 1%, with gross deferred revenue growing 6%. The remaining performance obligation, or RPO, balance is $38.5 billion, up 13% in constant currency due to very strong bookings. Approximately 59% is expected to be recognized as revenue over the next 12 months. As we've said many times before, we're 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 7 million shares for a total of 600 million as we reduced the buybacks in advance of the purchase of Cerner. We've paid out dividends of $3.5 billion over the last 12 months, and the Board of Directors again declared a quarterly dividend of $0.32 per share. Our business is strong as our fast-growing cloud business continues to become a larger proportion of the overall business. A few points. First, my guidance assumes that Cerner does not close in Q4, though it very well may close in the quarter. And again, Cerner should be accretive in the first year. Secondly, cloud is fundamentally a more profitable business than on-premise. And I expect that our full-year non-GAAP operating margins for fiscal year 2022, which we're finishing now, will be 1% to 2% higher than pre-pandemic levels of 44%. Let me now turn to my guidance for Q4, which I'll provide on a non-GAAP basis. Now the U.S. dollar strengthened dramatically in November. And as you all know, there were a lot of fluctuations this quarter. But assuming currency exchange rates remain the same as they are right now, I expect we will see a currency headwind of 2% to 3% on revenue and $0.05 negative for EPS in Q4. Of course, the dollar could easily strengthen from here. Total revenue for Q4 is expected to grow between 6% to 8% in constant currency and grow between 3% to 5% in USD. Cloud service and license support revenue for Q4 is expected to grow between 6% to 8% in constant currency and grow between 4% to 6% in USD. Non-GAAP EPS for Q4 is expected to be between 1.40 and 1.44 in constant currency. GAAP EPS is expected to be between 1.35 and 1.39 in USD. Now both non-GAAP and GAAP EPS are expected to decline year-over-year due to some large investment gains we saw last year as well as a very low tax rate last year. It was 10.7%. Both of these masked the strong earnings growth and momentum we continue to see out of our core cloud business. My EPS guidance for Q4 assumes a base tax rate of 19%. As I always say, however, onetime tax events could cause actual rates for any given quarter to be higher or lower, but I expect that in normalizing for these onetime tax events, our non-GAAP tax rates will average around 19% or so. And with that, I'll turn it over to Larry for his comments.

Larry Ellison, Chairman and Chief Technology Officer

Thank you, Safra. I have two parts to my comments. I'll begin with our ongoing business performance, highlighting our progress in ERP and HCM cloud services, including wins and go-lives within our strategic SaaS sector. Next, I will discuss our new MySQL HeatWave product. It's notable to mention that we've had unprecedented positive reception from both customers and analysts for this product, which might be the best response we've ever received in our history. I will elaborate on that shortly. First, let's assess our SaaS business. We're experiencing remarkable growth, particularly in ERP and HCM back office solutions. Q3 yielded an exceptional boost in ERP cloud sales, now exceeding 10,000 Fusion ERP and HCM customers. For the first time, we are seeing traction across various industries, beginning with healthcare, which is the largest industry globally. In healthcare, we're engaged with significant providers like Tenet Health, Kaiser, Mayo Clinic, Cleveland Clinic, Northwell Health, Mount Sinai, and Atrium Health. We've also partnered with additional healthcare organizations, including CHS Community Health Services, consisting of 83 hospitals, achieving ERP, HCM, and SCM wins there while replacing Kronos. This is particularly noteworthy as the hospital sector operates similarly to a gig economy, with a workforce comprising professionals who are not permanent employees, making workforce management a complex challenge. Our HCM systems are tailored to assist in recruiting, tracking, scheduling, and compensating healthcare professionals. We're starting to replace Kronos in hospitals, which is significant. Furthermore, we secured an HCM deal at TriHealth, outmaneuvering Workday, and gained traction at Loma Linda University's healthcare center, which is already utilizing our ERP. The healthcare scope extends beyond hospitals to include medical device manufacturers, pharmaceutical companies, insurers, and government entities. For example, we achieved a notable ERP deal against SAP at Johnson & Johnson and at Haemonetics, a medical device firm, alongside securing an ERP deal at the Saskatchewan Health Authority, which predominantly involves government payers. We're committed to serving the entire healthcare ecosystem, which is why our acquisition of Cerner was strategic. We've seen impressive go-lives, such as at Franciscan Missionaries health system with over 20 hospitals, INTEGRIS Health with 16 hospitals, and Nemours Children's Health serving 34,000 users. In the financial services sector, we maintain a strong standing, partnering with firms like Bank of America, JPMorgan Chase, Santander, HSBC, and others. We've successfully won ERP contracts at TD Bank and Silicon Valley Bank against SAP and have expanded our relationship with JPMorgan Chase in HCM. In communications, we have notable clients like AT&T and MTN, and we've secured a significant ERP win at Rogers Communications. In logistics and transportation, our major partnerships include UPS and FedEx, along with recent ERP wins at U.S. Express and HCM wins at TD Freight. In Germany, we've made strong inroads, winning contracts with Deutsche Post, Deutsche Bahn, and other entities while also establishing a presence in Japan with firms like Panasonic and Toyota, alongside recent wins at Canon and Taisei. In the grocery sector, we noted substantial expansions at Kroger and Albertsons, while in hotels, our partnerships with Marriott and Hilton continue to thrive. Our higher education clients now include the University of Cambridge and additional campuses in the University of California system. Across various industries, including aerospace, defense, public sector, and high tech, we've achieved significant wins over SAP, demonstrating our growth and competitive edge throughout diverse markets. The quarter was exceptionally strong for us in ERP and HCM. Transitioning to infrastructure, we have a major announcement regarding MySQL. While MySQL is renowned for transaction processing, it has historically fallen short in query processing. Typically, customers use MySQL for transactions and rely on solutions like Redshift or Snowflake for queries. However, with MySQL HeatWave, we've developed a product capable of excelling in both transaction and query processing, making it superior to both Aurora and Redshift. MySQL HeatWave is now a multicloud solution, functioning across Oracle Cloud, AWS, and Azure, allowing users a seamless transition from competitors with just a few clicks. The cost-performance advantages of MySQL HeatWave are compelling. Now, I will share some analyst feedback that highlights these strengths. One analyst noted that together with Autopilot, MySQL HeatWave may represent the most significant innovation in open-source cloud databases in the last two decades. Another stated that it offers significant improvements in query performance and transaction support, positioning Oracle to challenge competitors in the database market. The advantages of MySQL HeatWave are substantial, outperforming Amazon Redshift and Snowflake and delivering remarkable cost efficiency. As the cloud data warehouse market reacts, organizations currently using MySQL have an added incentive to transition to HeatWave due to its impressive performance and cost benefits. This new approach has raised the stakes in the industry, demanding rapid responses from competitors. Overall, MySQL HeatWave is a product of extensive engineering expertise, evidenced by numerous patents, and signifies real innovation in cloud databases. I'll pause here and hand it back to Safra.

Ken Bond, Senior Vice President

Thank you, Larry. Holly, if you could please prepare the audience for Q&A portion of the call.

Brad Zelnick, Analyst

Congrats on the continued momentum and especially all those great customer wins, Larry. I have one quick one for Safra and then a follow-up for you. Safra, just looking at my model, it looks like you had your strongest organic revenue growth in 10 years this quarter. And I just want to make sure I've got that right, and I'm not missing anything.

Safra Catz, CEO

Yes, you’re correct. As I’ve mentioned previously, our cloud business, which is our fastest-growing sector, is now expanding significantly. When you have different parts of the business growing at rates of 25%, 30%, 40%, and even 60%, it leads to substantial figures, and it simply comes down to the math. This acceleration contributes to the overall growth rate of the business.

Lawrence Ellison, Chairman and Chief Technology Officer

I believe it's widespread. We're collaborating with one of the largest banks in the world on a business-to-business payment system because enterprise resource planning customers are turning to Oracle. Looking ahead, given our strong position in Cloud ERP, B2B purchases will involve one Oracle ERP system making purchases from another Oracle ERP system. We aim to automate these B2B transactions, which means the two Oracle ERP systems need to communicate effectively. To facilitate this, we need to handle payments, assess credit, and manage various logistical aspects. We're partnering with a major bank and a significant logistics company to streamline this part of our ERP business. It's not something you typically associate with ERP, but it's about creating a network of interconnected ERP systems. This represents a substantial revenue opportunity to activate that B2B payment system. Banks and logistics firms are getting involved because our customers are here. Once ERP customers began partnering with Oracle, numerous adjacent applications and independent software vendors wanted to join the same cloud as these ERP users. Integrators also had to adapt to the cloud environment since that's where the customers are headed. Notably, large banks and logistics companies are deploying their logistics and payment systems in our cloud to enhance B2B transactions between our ERP systems, presenting an enormous business opportunity that hadn't been previously considered.

Raimo Lenschow, Analyst

I'm trying my luck here, Safra, but I'd like any comments on the TikTok rumors that came out today? And then in case you want to answer that. Larry, one for you on that success in the back office systems, like is that driven by post-pandemic people realizing, oh, shoot, I really need to update that. So that's kind of more temporary boom that you're seeing here? Or do you think there's more legs to that?

Safra Catz, CEO

The one thing I can tell you is we have an excellent relationship with the folks at TikTok.

Lawrence Ellison, Chairman and Chief Technology Officer

Yes, I agree. It's excellent. To address the other part of your question about whether this resembles a pandemic boom like in the year 2000, with people rushing to the cloud and then slowing down as the pandemic recedes, I believe it's quite the opposite. We're still in the early stages of understanding how different Cloud ERP is from on-premise ERP. For example, in the current landscape, as more people adopt Cloud ERP, interactions often occur between Oracle ERP systems. This requires coordination with financial partners and multiple logistics partners to automate the processes of financing and transporting products, as well as tracking delivery timelines. Therefore, I truly think we are still in the very early days. Although we now have 10,000 customers using Oracle ERP Fusion and nearly 30,000 total customers including NetSuite, I still feel we are just starting out. The pace is increasing. Our growth is accelerating significantly. Our growth rate isn't falling; it's actually growing, with mid-30s to high 20s growth rates with NetSuite and Fusion, even as we have more than doubled in size.

Philip Winslow, Analyst

Congrats on another quarter of accelerating growth. One comment from your script today really stood out to me, and that was continued to grow profits while we push our top-line growth into the double digits next year. Now obviously, this is continued reacceleration from the 6% to 8% the past 2 quarters and your guidance, obviously, on a constant currency basis for Q4. So my question to you, Safra and Larry is, can you help just unpack this for us in terms of the puts and takes between database and apps, cloud on-premise, et cetera, that give you confidence for continued acceleration in the double digits, but also, like you said, while growing profits?

Safra Catz, CEO

We have made substantial investments this year, with our capital expenditures doubling compared to last year, as we've been enhancing our capabilities globally. At the same time, our revenues have risen. Although we faced some declines in certain segments of the business over the past few years, this quarter has shown that all areas are now experiencing growth. Various business lines are seeing booking increases, with some exceeding 100%. Most of our business is growing, and the negative aspects are now minimal. For instance, the application license segment is now quite small. Meanwhile, our technology licenses are performing exceptionally well, with a 9% increase this quarter. The cloud business is thriving, evident in the numbers for ERP, HCM, OCI, and autonomous database, all of which continue to grow significantly. The areas that were previously shrinking are now experiencing much less decline. With some relief in the supply chain, allowing us to fulfill all our bookings, we anticipate overall growth and are optimistic about the coming year.

Keith Weiss, Analyst

Congratulations on a great quarter. It's great to see the momentum really showing through to the results now. Last quarter, you guys talked a lot about an increasing focus on verticals, particularly banking and health care. This quarter, you're talking about rolling up some of those verticals. Can you talk to us a little bit more about the approach on how you build up and create that roll up in the vertical? How much of that effort is building like vertical-specific products? How much of it is a new go-to-market strategy, if you will, or aligning the go-to-market strategy for those verticals? And how much work is left to be done on those two sides?

Lawrence Ellison, Chairman and Chief Technology Officer

Let me begin with health care. People often think of health care as a specific area, and Cerner operates within that space, competing for provider attention. However, health care encompasses much more than just that. There are clinical trials run by pharmaceutical companies, and while they pay for these trials, it is actually the providers who conduct them. No one has ever attempted to manage the entire health care ecosystem. To address your question, we are significantly enhancing our human capital management system for hospitals, enabling nursing staff to work varying schedules, such as three or four days a week, and allowing doctors to serve at multiple hospitals. Scheduling these independent contractors can be quite complex, as hospitals are comprised of both full-time workers and independent contractors, making scheduling and payment intricate, particularly when union regulations are involved. Thus, we are introducing numerous industry-specific features to assist hospitals in managing their workforce. When it comes to hospital inventory, it isn't just located in a warehouse; it is dispersed throughout the facility. For instance, important medications, like tranexamic acid, must be readily available, especially in emergencies. This requires us to enhance how we track inventory using RFID tags, allowing quick access to crucial supplies scattered across the hospital. Furthermore, before a doctor can authorize any medical test or prescription, they must first confirm with the insurance company regarding payment coverage. This negotiation process can consume a lot of time for both doctors and hospitals, often involving discussions over whether specific tests or medications will be covered based on a patient's symptoms. We are working on automating the communication between payers and providers to streamline these interactions. We believe we are well-positioned to integrate the health care industry, which is vast and largely unaddressed in terms of ecosystem integration. We have the necessary components in place: payment processing, automation for insurers, human capital management, and enterprise resource planning to effectively manage inventory. Soon, we will also have Cerner to assist in patient care delivery. With our clinical trial system for pharmaceutical needs, we’re connecting all these components to enhance the efficiency of the ecosystem for the first time. The pandemic has highlighted the urgent need for such a cohesive system.

Safra Catz, CEO

Okay. Let me just say one other thing. So we have a number of vertical industries in which we have products, and our competitors don't have products. And this has been a core part of how we work. We work with retailers. We work in financial services. We work in utilities. We work in construction engineering. We don't just modify ERP systems slightly and say we're in the industry. We're actually in operational systems in the industry, and it brings incredible value to our customers to be able to use these products.

Kirk Materne, Analyst

Safra, I was hoping you could expand a bit on the strength in Cloud at Customer. And just really 2 things about that. How should we think about Cloud at Customer being somewhat of a leading indicator for adoption of autonomous database? And then are any of the supply constraints starting to loosen up a bit on that front in terms of maybe helping to accelerate rev rec in that area over the next couple of quarters?

Safra Catz, CEO

I acknowledge that the last couple of years have been quite challenging, and I am very proud of our team. Our strong relationships with our exceptional suppliers have enabled us to expand our cloud services and provide hardware to our customers. While we haven't been able to meet every demand as quickly as we hoped, we do have a significant backlog. This backlog gives me clear insight, as our customers have expressed their desire for Cloud at Customer or hardware, and I can see how to fulfill these requests in their facilities. We are managing a lot simultaneously. We have expanded our cloud internationally and created several private clouds that offer the same capabilities as our public cloud for customers with specific regulatory needs. We are addressing everyone's requirements. The optimism you hear from me and Larry reflects our clear understanding of the strong demand we are encountering and our ability to deliver on it. Although I don't read newspapers in the traditional sense, I am aware of everything happening around us. I have great confidence in my team's ability to execute.

Ken Bond, Senior Vice President

Thank you, Holly. 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 it back to Holly to close the call.

Operator, Operator

Once again, we'd like to thank you for participating in today's Oracle Third Quarter 2022 Conference Call. You may now disconnect.