UPDATED 26 March 2008
Overall Q3 results for Oracle (MGI: 2,210) have been viewed as somewhat disappointing. Given the substantial number of acquisitions the company has done over the past several years, not to mention Oracle’s broad international exposure, many investors have come to think the company is fully insulated from the risks of an economic slowdown. Obviously this was a flawed assumption.
We believe looking at Oracle’s MGI Index performance helps put the results into better perspective. As we have written on previous occasions Oracle has one of the highest MGI X index scores for applications software vendors (“ASVs”). Oracle’s score currently stands at 2,210 as of the February quarter, and Oracle’s rank was #2 out of the 65 ASVs we track. While Oracle has an excellent score, the Change Vector (which we believe performs as something of an intermediate leading indicator of future results) was modestly negative in the August and November quarters (see chart below). The February quarter, although disappointing to investors, did show a return to a positive Change Vector reading which we believe bodes well for the May quarter performance.
Given that Oracle was closing the quarter during a period of extraordinary volatility in the financial markets, coupled with an extremely challenging year-ago comparison, we would not read too much into the numbers relative to where Q4 results will be. Likewise, our checks during the quarter suggested that there could be some delays in closing the business, particularly in key verticals like retail and financial services. The most pronounced area of weakness in the quarter was the modest applications’ license growth. This should not be terribly surprising given the extraordinary year-earlier growth as well as the fact that applications deals tend to be bigger and carry more associated expenses of deployment. We had also heard that Oracle had taken steps to incrementally tighten spending on travel and discretionary expenses.
We view the strong earnings growth that was in large part driven by continued significant improvements in operating profitability as evidence of both the leverage of Oracle’s increasing scale as well as the effectiveness of the company’s internal reporting systems. Perhaps as important, management’s comments regarding the strong sequential growth in its pipeline (not quantified) indicates the future remains bright. Management on balance is quite confident and it appears to us that Q4 could very well upside estimates.
[Due to a typographical error, this post has the updated and correct MGI X score for Oracle - 2,210.]
A High Level Summary of the Q3 Results
Q3 customers getting a little more cautious – with some deals being delayed – management stated that they have built this into their close process.
License revenue growth for the quarter at 16% was at the lower end of the guidance range of 15% to 25%. Constant currency growth was 9%.
Total revenues were up 21% and in constant currencies at 15%.
Applications license revenue growth was up 7%. Technology license revenue growth was up 20%. Management indicated that both businesses were affected by a somewhat longer sales cycle, however given that applications deals are often larger, the impact was more obvious in the applications business.
Applications license revenue had an extremely difficult year ago compare with Q3 of ’07 up 57% y/y. Americas grew 17% y/y; EMEA grew 26% and Asia/Pacific grew 25%.
Management reiterated their confidence in the strategy, as well as their sales execution and highlighted that there continues to be a good deal of further leverage in profitability.
The real story in Q3 was margin performance, which exceeded in expectations. Operating margins were 35%, vs. 32% a year ago. Year to year growth in operating income was 35%, in constant currencies it was 24%.
• Cash flow for Q3 $6.9 billion up 48% y/y.
• Sequential growth in the pipeline for Q4 is greater than it was a year ago.
• Q4 close rate assumption is 5pts lower than it was for the prior quarter.
• Currency rates if they remain where they are for Q4 should contribute 7pts to growth.
• During Q3 Oracle bought back 24m shares at an average price $20.64.
BEA deal has passed Hart-Scott Rodino. Oracle should get approval from Europe during Q4 and the deal is expected to close during the quarter.
Guidance for Q4; new license revenues are expected to be up 10% to 20% y/y (pipeline could support significant upside); total revenues should be up 14% to 18% (non-GAAP), 16% to 19% (GAAP); non-GAAP EPS approximately $0.43 vs. $0.37 a year ago, GAAP EPS $0.37-$0.38 vs. $0.31; tax rate should be 28.6% vs. 29.2% last year.