Oracle Q2 Earnings: Past Bookings Boost Cloud Revenues; No Respite for On-Premise Business
Oracle Corp. (NYSE:ORCL) reported its fiscal 2016 second quarter results on December 16th. [1] (Fiscal years end with May.) The company’s cloud business achieved strong revenue growth as past bookings began translating to revenue in the second quarter. In the legacy on-premise software licenses business, update and support revenue grew nominally, helped along by high attach and renewal rates. However, sale of new software licenses continued to decline. Unless Oracle is able to prop up sales of new software licenses, it is unclear how long the growth of update and support revenues can sustain growth.
Oracle fiscal 2016 second quarter performance snapshot:
- Revenues declined by 6% year on year to $9 billion (flat in constant currency terms)
- Non-GAAP operating margin contracted by 5 percentage points to 41%
- Non-GAAP EPS was $0.63 compared to $0.69 in the prior year period
Our price estimate of $39 for Oracle Corp. is nearly the same as its current market price.
See our complete analysis for Oracle Corp. here
Cloud Revenue Growth Accelerates on Past Bookings
Oracle’s triple digit growth in bookings over the last few quarters started paying dividends in the second quarter as past bookings began yielding revenue. When a new cloud computing contract is acquired, revenues therefrom are not booked immediately but are instead recorded off-balance sheet as bookings. Revenue from such new contracts is recorded when the new customer starts using the cloud services. The time-gap between booking and revenue realization exists because of the time required for installation and data integration.
Thus, new bookings that were acquired over the past two years have now started translating to revenue for the company. The trend is expected to accelerate in the back half of the current fiscal year and continue in fiscal 2017. [2] Revenue growth of Oracle’s Software-as-a-Service (SaaS) and Platform-as-a-Service (Paas) segments is guided to be around 50% year on year in the third quarter, and over 65% year on year in the fourth quarter in constant currency terms. [2]
It should be noted that the acceleration expected in the SaaS and PaaS segments will not be present in the Infrastructure-as-a-Service (IaaS) segments. To the contrary, revenue growth of the IaaS segment is expected to slow to mid-single digits in the near to medium term. The expectations of slow growth in the IaaS segment lends credence to the claims that Oracle is at least six months away from issuing a meaningful challenge to Amazon (NYSE:AMZN), the de-facto leader in the global IaaS market. [3] (Read: Oracle Has Grand Plans For Cloud Computing – But Is It Too Late To The Party?)
Cloud Margins on the Rise
An ancillary benefit of the conversion of bookings to revenues is a sudden spike in the SaaS and PaaS bottom line. This is because the costs involved with acquiring new contracts, which includes the cost of building data centers, was already booked at the time of acquisition of new customers. Thus, the conversion of past bookings to revenue at the present is not accompanied by a proportionate increase in costs associated with this incremental revenue, leading to a jump in margins.
This is not yet fully obvious in the 3 percentage point sequential increase in SaaS and PaaS gross margin, which is up from 40% in the first quarter to 43% in the second quarter. However, it is likely to become evident in the next few quarters as SaaS and PaaS gross margin is expected to jump to 55% to 60% by the end of the current fiscal year. Oracle is targeting to improve the figure to 80% by fiscal 2018. [3]
Update and Support Revenues Propping Up On-Premise Software Business
In contrast to the bounding cloud business, Oracle’s legacy on-premise software business continues to be beleaguered by sluggish growth. Sales of new software licenses fell yet again in the second quarter by 18% year on year as reported, and by 12% on a constant currency basis. Comparatively, revenues from sales of new software licenses had fallen by 16% year on year in the first quarter, suggesting that the pace of decline may be increasing. Pending data bes releases may be suppressing demand at present.
Revenues from update and support services declined by 2% year on year in as-reported terms. However, growth therefrom managed to remain in the black in constant currency terms with a 5% year on year expansion. The positive constant currency growth in update and support revenues is attributed to the attach and renewal rates of Oracle’s customers, which has historically remained above 90%. This is because on-premise database software, which comprises a bulk of Oracle’s on-premise software sales, is a mission critical component for most companies and involves high switching costs. Given the critical nature of database software, most existing customers are likely to stick with Oracle for the foreseeable future. However, its market share in the on-premise software market is likely to decline in the absence of new customers.
Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap
Notes:- Oracle Investor Relations [↩]
- Oracle Fiscal 2016 Second Quarter Earnings Call Transcript, Seeking Alpha, November 17, 2015 [↩] [↩]
- Oracle insider: We’re not walking the cloud talk, Info World, November 9, 2015 [↩] [↩]