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Oracle Corporation
Solid, but not Spectacular Earnings...

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By zoningfool
December 20, 2006

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...at least not as spectacular as we've been getting...

Looking at the numbers, Oracle clearly had a solid quarter--they met Street expectations on the bottom-line, posting an EPS of 22 cents, which was right in line with consensus, and blew-out the top-line consensus of $4.15B by posting non-GAAP sales of $4.216B ($4.163B on a GAAP basis). Earnings growth was 21% on a GAAP basis, 20% non-GAAP. Revenue growth was even better at 26% on a GAAP basis, 24% non-GAAP.

That is the forest. Looking at the trees:

New software licenses were up only 14%, 10% in constant currency. The company had given guidance of 15%-20% YoY growth. Clearly a disappointment. They blamed the shortfall on execution. From yesterdays' cc:

As we have looked at the new license results, we believe it basically came down to execution on a number of deals that did not close in the quarter. These were not competitive losses either in technology or in apps, and these deals should close in Q3.

On the positive side, they are taking corrective measures to deal with this:

We think that additional focus and better pipeline management should result in higher conversion rates and much better execution in the third quarter. Focus to us means reducing the time spent on internal meetings and non-core sales activities, leaving the field more time to work with customers and close deals.

And while execution was lacking in Q2, the pipeline appears to remain strong:

Safra Catz:

.... pipelines are actually up very significantly, actually 35% sequentially, so we are optimistic we should do quite well....

LJE:

...Going forward, we think the retail business is going to be large enough in the second-half to actually move the needle, so we are very excited about the strong growth in our retail business, as evidenced I think with the pipeline. Safra mentioned that growing pipelines, sequential pipelines Q2 going to Q3, a portion of that are these new vertical businesses, especially the most mature of those, retail. Again, retail looks very, very strong going forward....

..., we are very happy with our vertical applications. The acquisition strategy, we think it is really beginning to produce and will move the needle in the second-half. ...


Breaking down the new software licenses: database license sales were up an anemic 9% YoY, 5% in constant currency. Applications license revenues were up a 28% YoY, 25% in constant currency. This is solid growth, however, compared to the mind-boggling growth rates over the prior quarter (77% in Q3 2006, 83% in Q4 2006, and 80% in Q1 2007), this pales in comparison. Not to fear, however, Q2 2006's growth rate was only 24%--this followed a Q1 2006 growth rate of 84%. So, while the deceleration in growth is a concern and bears watching, one "off" quarter should not cause investors to throw in the towel, especially given the corrective action the company is undertaking to convert the pipeline into new deals. And there is every reason to believe that growth rates will re-accelerate in the second half of the fiscal year.

Some comments from the cc:

Safra Catz:

....I think what we are going to see in the second-half is that both the database and all the options, as well as middleware, will all pick up in the second-half. We are going to be a little more back-end loaded this year.

LJE:

...We think those deals are going to be coming back in Q3 and maybe a few in Q4. Safra mentioned we are going to be a bit back-end loaded this year, like we were last year, by the way. Our business is shaped a little bit different than it has been historically, so we expect those deals to come in....

Charles Phillips:

... Then we do have, I think as Safra mentioned, some growing backlog. A lot of the acquired companies in the industry areas we are recognizing either on implementation or on a ratable basis. As we reach steady state in that business, we can start to recognize more of the backlog as well....

On the applications, I do not think it is tied to one or two big deals or a small number of big deals. We have a lot of things happening that should help us. A lot of the integrations we have been talking about start to show up in the second-half, and that is important to customers, and certainly demos, great, they start to get the idea of having the best-of-breed products for every function, but yet we are responsible for the integration, kind of a virtual suite.

That is going to be a strong story in the second-half. ...


While new license sales fell short of expectations, total revenues came in at the upper end of the guidance range. Guidance had been for growth of 22% to 24% on a non-GAAP basis and 24% to 26% on a GAAP basis. Actual non-GAAP revenues grew at 24%, GAAP revenues at 26%.

So, the flip-side to the disappointing new license revenues, in light of the company posting better-than-expected revenues, is that other areas of operations must've taken up the slack. The largest revenue driver for Oracle is support. Support revenues comprise approximately 50% of total revenues, consulting 17%, with On Demand and Education in the low single digits (3% and 2% respectively). The chief source of revenues, support, grew at 29%. Consulting grew at 42%. On Demand at 61%.

From the cc on the topic of the strength in support revenues:

The renewal rates of this very large recurring revenue stream remain extremely high, above 95%, as our customers continue to renew their contracts and as customers come back to Oracle after not renewing in previous years under a different ownership. Q2 license renewals revenue exceeded our internal forecast.

And keep in mind, support revenues are where the money is, contributing to the majority of profits, with margins of 90%.

So, along with the strong pipeline, the high renewal rates are another good sign for the future as the customer base and support revenue stream keEPS growing every year, bringing high margins with them.

The negative offshoot of the higher-than-expected top-line, especially in light of the growth in support revenues, is the EPS number only meeting forecasts. It seems reasonable to conclude that EPS should've been higher--the growth on a non-GAAP basis was only 18%, 20% on a GAAP basis. Looking at the income statement, we see that the operating expenses line items of sales and marketing and G&A grew at 41% and 56% respectively. Cost of services (which I include in cost of sales rather than operating expenses in calculating gross margin) grew at 41%. Clearly there is room for improvement in these expenses and that is something Oracle is attending to--From the cc:

We expect margins to improve for the year and that improvement will show up next quarter and in Q4.

And this on margins from the Q&A:

Kirk Materne - Banc of America

Thanks very much. Safra, you noted that you are expecting some margin expansion in the back-half of the year. Is this generally just revenue leverage that you are getting off the top line as that accelerates in the back-half of the year? Are there any cost measures that you are going to see some benefits from as well?

Safra A. Catz

We usually ramp up spending, and our spending is pretty even throughout the year, other than commission expenses. What happens is a lot of the revenue obviously comes in at the second-half. We spent a lot in building sales coverage and we expect that the revenue is going to come and meet that and improve our margins, give us a lot more leverage as the revenue comes in.


Given what occurred in fiscal 2006 (the re-acceleration of growth, primarily in applications), the addressing of the execution issues, the expected margin improvement as well as the fact that historically Q3 and Q4 have been the strongest quarters, we may very well get that "strong story in the second half" and see Oracle regain its luster in the near future.

Holding on,
zf


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