Larry Ellison just gave a really good reason why he was happy with Oracle’s disappointing quarter

Larry ellison
Oracle Executive Chairman Larry Ellison Kimberly White / Getty Images

Although Oracle whiffed on its fourth quarter, missing expectations on both revenue and profits in the quarter that is traditionally its strongest, Oracle’s management was upbeat, almost deliriously so.

“We are delighted with this quarter,” one of Oracle’s CEOs, Safra Catz said on a quarterly conference call with analysts.

The reason: Oracle blew way past its own internal expectations for cloud computing sales.

Oracle gained $US426 million of new cloud revenue, on an annual recurring revenue basis. Management had projected it would do $US300 million in the quarter, Oracle’s other CEO, Mark Hurd, said.

And these executives are happy because Oracle makes three times more money over the long run on cloud than they do on software, they say.

Catz explained that a $US1 million software licence deal will ultimately generate $US3 million for Oracle because customers will pay for extended technical support.

But a $US1 million cloud contract will ultimately generate $US10 million for the company, because customers must pay for the software on subscription for as long as they want to use it.

The downside: the accounting is different. With a software sale, the whole $US1 million can be shown as revenue immediately. With cloud, the $US10 million is recognised only when it is billed.

So even though the cloud contract is worth more, as Oracle shifts its customers to the cloud, it can look like revenue is shrinking.

Big profits in cloud, too

Oracle Safra Catz
Oracle CEO Safra Catz Business Insider/Julie Bort

Ellison explained that selling applications via the cloud is about equally profitable to selling a software licence, too.

There are two profitable ways to sell apps via the cloud, Software-as-a-service, (SaaS) which delivers an Oracle application over the internet; or Platform-as-a-Service, (PaaS) which hosts custom applications that the customers develop themselves.

“On a $US1 million deal of licensed software, you’ll get about 20% [in support revenue] for two years, so you’ll get a total of $US3 million after the cost of sales. It’s a very profitable business. Most of that $US3 million after the cost of sales is profit,” Ellison said.

“On a $US1 million SaaS or PaaS deal, you don’t get anything up front but you have to pay commissions. But a $US1 million deal is worth 3 times as much,” he said. “That $US1 million turns into something less than $US10 million in profits, say $US9 million in profits, over the life of providing the service. It’s a much better business for us in terms of revenue and the margins are about the same.”

He’s being a little grandiose for the sake of example. Oracle’s overall operating margins (excluding extraordinary items) was 45% in 2015. But point taken all the same.

Mark Hurd speaking
Mark Hurd addressing the Oracle troops Oracle

Oracle has another advantage in making cloud profitable, Catz points out: Oracle makes all the things it uses in its cloud, the hardware and the software.

It doesn’t have to buy expensive hardware or software from others. So it is in some ways, the master of its own profit margins.

Hurd also pointed out that the cloud is allowing Oracle to reach brand new customers. Smaller companies can buy Oracle’s software delivered as a cloud.

These same companies couldn’t afford to buy it as a software, buy the hardware to run it on, and hire the IT people to manage all that.

Investors were a little more cautious. Cloud computing is currently only 6% of Oracle’s total sales in its fiscal 2015 (about $US2.3 billion out of $US38.2 billion in revenue). While Oracle says that all of its business are also growing, new software licenses were down 4% in constant currency for fiscal 2015. The stock was down over 6% in after hours trading.

Catz promised that the proof of the goodness of cloud will soon show up in Oracle’s quarterly financial reports. Cloud revenue should grow sequentially from quarter to quarter, and be less dependent on seasonality, she said.

NOW WATCH: Two models in Russia just posed with a 1,400-pound bear