What Oracle's Guidance Really Means

Another set of earnings meant another disappointment for Oracle (NYSE: ORCL  ) shareholders. Earnings, revenue, and key performance metrics all came in toward the bottom end of guidance, and Fools must be wondering just how reliable Oracle's guidance actually is? However, the company also made some reporting changes that should make its earnings easier to follow in the future, yet most of these adjustments simply reflect a change in industry-end demand.

In common with its main rival IBM (NYSE: IBM  ) , Oracle is shifting its efforts toward areas of growth such as cloud infrastructure. The question is, how will Oracle's new guidance help Fools to better follow the company?

Oracle's earnings disappoint
There is no way to sugarcoat it -- Oracle's fourth-quarter results were disappointing.

  • New software licenses and cloud subscription growth came in at 1%, versus guidance of 0%-10%.
  • Hardware product growth came in at 2%, versus guidance of 0%-10%.
  • Revenue growth was 3%, versus guidance of 3%-7%.
  • Non-GAAP EPS was $0.92, versus guidance of $0.92-$0.99.

Management was quick to point out a currency loss in Venezuela, which cost the company nearly $0.02 in EPS, but against that, the non-GAAP tax rate came in lower than expected at 23%, adding to EPS growth.

In short, it was a disappointing set of earnings. However, a structural change in Oracle's business generation is making it harder to compare revenue and earnings generation on a like-for-like basis. In common with IBM, which is also investing heavily in the cloud, Oracle's management believes it will be able to expand cloud-based software sales by investing in cloud infrastructure. While this is a laudable idea, investors should recognize that a host of other companies, including IBM, are also investing in the same idea. However, Oracle's key attraction is its range of cloud-based software solutions, which it can tie into its cloud infrastructural offering. In comparison, IBM's focus is on developing its own growth areas such as its big data analytics capability via its Watson supercomputer.

Oracle's changing business model
The key to Oracle's future is its ability to manage the transition from traditional on-license on-premises sales toward cloud-based subscription sales. Investors should keep a close eye on this transition, but also remember that when software companies shift from one-time traditional license sales toward cloud-based subscription sales, it usually involves vendors receiving lower initial revenue in favor of larger income streams in the future. The idea is that a customer buying a cloud-based subscription will generate a higher lifetime value for Oracle.

When discussing the issue on the conference call, CEO Larry Ellison outlined the concept of Annual Recurring Revenue, or ARR:

Roughly speaking, ARR is one-third of a license. It's not precisely right. It differs a little bit by solution, but it's roughly right. So, therefore, we take roughly three years for somebody to get to the same productivity of what you'd think of in the license model.

In other words, if Oracle shifted all of its license sales to cloud-based subscription sales in one quarter, its software license revenue would drop by two-thirds. Furthermore, if cloud-based subscriptions come in greater than expected (as customers switch to these options, rather than on-premises on-license sales), forecasting future overall software licenses and subscriptions will be difficult.

How Oracle is reporting and giving guidance
The good news is that Oracle is now breaking out its cloud-based revenue. Focusing purely on its software and cloud revenue in the fourth quarter (representing 79% of overall sales), the breakout is as follows:

Fourth Quarter Revenue ($m) Constant Currency Growth % of Revenue
New Software Licenses 3769 (1%) 33%
Cloud Software-as-a-Service and Platform-as-a-Service 322 25% 3%
Cloud Infrastructure-as-a-Service 128  13% 1%
Software License Updates and Product Support 4695 4% 42%
Software and Cloud Revenue 8914 7% 79%

Source: Oracle Presentations

To put these figures into context, consider the second line in the table. Purely for argument's sake, if the increase of 25% ($65 million) came completely from cloud subscriptions (at the expense of new software licenses), then the foregone new software license revenue would approximate (based in Ellison's comments above) to $195 million. If so, then the $195 million would have represented a 5.1% increase in new software license sales, when in fact Oracle reported a 1% decline on a constant currency basis.

Furthermore, Oracle gave specific guidance for the software line items in the table above, and Fools should look out for these estimates in the next quarter's results.

  • First-quarter software and cloud revenue is expected to grow 5%-7% in constant currency.
  • Non-GAAP cloud-based software-as-a-service and platform-as-a-service revenue is forecast to grow 24%-34% in constant currency.
  • Cloud infrastructure-as-a-service is expected to grow 9%-19% in constant currency.

The bottom line
Oracle's earnings were disappointing, but as its cloud-based subscription sales accelerate, investors should prepare for some more volatility in the revenue line. In fact, Oracle wants to increase subscription-based sales because they generate a higher lifetime value to the company. It's also interesting to contrast Oracle's flexible approach to developing its business with that of IBM, which appears to be wedded to the idea of hitting its EPS target of $20 by the end of 2015.

The new software revenue breakout and guidance is very useful because Fools will be able to see how the software segment is performing, without being encumbered by confusion related to losing larger upfront software license sales.

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