Wall Street unimpressed as Ellison argues Oracle's profit miss is due to cloud success

Oracle President Mark Hurd once fixed me with a beady stare and asked rhetorically how long I thought Wall Street would put up with excuses from pureplay cloud computing firms about why they weren’t turning a profit. (He had Salesforce.com in mind at the time of course.)

That conversation came to mind yesterday as CEO Larry Ellison went into bat on the back of a weaker-than-expected fourth quarter set of numbers to argue that the profit miss is actually a positive sign of Oracle’s transition to a cloud-centric operating model.

What’s sauce for the goose isn’t SaaS for the gander! (Sorry!)

Mind you, it's not as if Oracle isn't turning a profit. It is - and a pretty damn healthy one at that of $3.6 billion for the quarter.

But Wall Street, used to the fourth quarter being the most successful for the firm,  wasn’t impressed and sent the share price down by nearly 9% after the results were announced.

For his part, Ellison argued the firm was well on course in its move to the cloud:

Oracle is focused like a laser on one goal over the next few years becoming the number one company in cloud computing’s two most profitable segments, Software-as-a-Service, SaaS; and Platform-as-a-Service, PaaS. We expect to become number one for three reasons.

First, we have the most complete and modern portfolio of SaaS products in the cloud. CRM sales, CRM service, marketing and human capital management, we have core human resources recruiting talent management and payroll. In ERP we have accounting, procurement, supply chain, project management and more, the most comprehensive suite of products in the cloud that far.

Second, all of those SaaS applications run on the world's most powerful platform in the cloud, the Oracle in-memory, multi-tenant database and the world's most popular programming language, Java.

Third, we have dramatically expanded, specialized and lined up our sales forces to sell SaaS and PaaS subscriptions against the new generation of cloud software competitors and its working. As we enter our new fiscal year, we are already number two in overall SaaS subscription sale. In FY '15 our plan is to grow our SaaS bookings over 50%. That will allow us to close in on the number one spot.

He added:

I think everybody wants our cloud business to get bigger, I certainly do. We actually make more money when we sell a cloud subscription. We get about the same amount of money from a subscription after three years [that] we get from a license.

Well, these subscriptions last three, four or five, 10, 15, 20 years, so we make a lot more money on a subscription, but we recognize the money over time. So as we make the transition to selling more cloud software services as opposed to upfront licenses, we will recognize the cloud revenue over time. Eventually, that cloud revenue eventually will grow to be even bigger than our license revenue…and we will make more money doing that over time.

So we are going to recognize the revenue more slowly…That's okay, because in the long-term we make much, much more money. And we can adaptively compete against this whole new array of competitors like Salesforce and Workday versus the previous generation of competitors like SAP and IBM.

Cloud breakdown

The firm is now breaking out its cloud revenues a bit more, taking what was previously reported as new software license and cloud subscription and moving to new software license with another line for SaaS and PaaS. The firm’s also now breaking out IaaS from services.

Some numbers of note:

• Fourth quarter SaaS and PaaS revenues were $327 million, up 23% year on year.
• Infrastructure-as-a-Service was $128 million, growing 13%.
• Software license updates and product support was $4.7 billion, up 6% in constant currency.
• A total of 870 cloud customers were added in Q4
• For the full 2014 fiscal year, total software and cloud revenues were $29.2 billion, up 5% in constant currency.
• Full year new software license was $9.4 billion, up 1%.
• Full year SaaS and PaaS revenues were $1.1 billion, growing 20% non-GAAP and 24% GAAP.
• Full year IaaS revenues were $456 million, up 1%.

Ellison argued that Wall Street should expect margins to hold firm:

The two parts of the cloud business that we're focused on are SaaS, the applications and PaaS, the platform database and Java programming language. We think inherently those businesses are 40%-50% margin businesses. We think that's not the case in Infrastructure-as-a-Service business. We think that's a lower margin business, but we think we can run it profitably in association with our SaaS and PaaS businesses.

Where we're really trying to grow the business, where we're determined to be number one is in SaaS and PaaS. We're in Infrastructure as a Service as a convenience to our customers, who want to have one-stop shopping and buy their applications platform and infrastructure at the same place. We think we can deliver the cloud services without compromising our margins whatsoever.

CFO Safra Catz did add the proviso to that:

The one thing that could maybe impact our margins negatively is if we are like voraciously successful with cloud in the next year or so such that a lot of revenue comes in this cloud even though I don't recognize it upfront. And so we have expenses, some expenses related to that, that are not matched by our other improvements in productivity in the rest of the business. Generally, I think we've got it very, very well balanced and I actually expect our operating margins to improve because we made the big investments in the field already.

She added:

We've successfully grown the company's revenues and earnings through every transition whether it was many computer database to a complete suite of products, client server to Internet, commodity hardware to engineer systems and now on-premise to cloud. We're well on our way into our most recent transition.

Verdict

It’s a long game of course, but those numbers didn’t make Wall Street happy.

The transition to deferred revenue argument is well-rehearsed of course, but the question around impact on margins is one that may need some work.

Techmarketview’s Angela Eager makes the point:

For the moment the margin expectation remains an unsubstantiated belief. There was some insight on price comparisons – broadly, the ARR [annual recurring revenue] on SaaS subscriptions is one third the cost of a traditional licence. After three years Oracle says a subscription will generate the same amount as a licence sales, thereafter the metrics (and margins) get better. This is a well-established argument, but only time will prove the level of return.

Meanwhile at Technology Business Research, principal analyst Matthew Healey suggests:

The adjustment to the reporting structure coming in Oracles historically strong fourth quarter is worth noting. Changing the reporting structure to a degree that an extensive explanation of the new structure was required could be viewed as a distraction from the weakness in the underlying business.

But he added:

Oracle spent a considerable amount of time discussing the transition to the cloud. As the revenue mix changes from an on-premises to a cloud model, the metrics that used to evaluate their financial performance need to change. By spending as much time discussing the changes, Oracle is demonstrating their commitment to the transition to the cloud.

The question is whether Wall Street investors, used to the fourth quarter being Oracle’s strongest, are up for getting their heads around the necessary transition to a different mindset when it comes to their expectations?

The reaction yesterday was one of disappointment based on previous experience with FBR Capital Markets analyst Daniel Ives going so far as to:

compare these results to Spain being knocked out of the World Cup in the first week.

There’s clearly still work to be done by Oracle on re-setting expectations.

 

Disclosure: at time of writing, Oracle, Salesforce.com, SAP and Workday are premium partners of diginomica.