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Risk

12/21/2009
05:52 PM
Bob Evans
Bob Evans
Commentary
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Global CIO: Oracle's Incredible Profit Machine: 22% Maintenance Fees

How important are your 22% annual fees to Oracle? It earned $3 billion on those fees last quarter while losing $800 million across the rest of the company.

Amid higher second-quarter revenue for new software licenses and annual maintenance fees, Oracle last month also reported higher net income due in large part to its phenomenally profitable annual maintenance business, which posted a dazzling operating margin of 91.9%. Yes, you read that right: an operating margin of 92%.

In a moment I'll share some comments from Oracle execs on that maintenance-fee performance (the formal name is "software license updates and product support"), but first, because you don't see 92% operating margins too often, let's take a closer look to see how this one came about.

For its second quarter ended Nov. 31, Oracle posted revenue of $5.858 billion, up 4% from the same quarter a year ago. That revenue comes from three buckets:

--New software licenses, where revenue was $1.653 billion, up 2% in U.S. dollars;

--Software license updates and product support (maintenance) of $3.247 billion, up 14%; and

--Services revenue of $958 million, down 15%.

For the second of those three—the maintenance bucket—Oracle breaks out specific expenses as well as revenue, and Oracle reported that the $3.247 billion in second-quarter maintenance revenue was associated with expenses of $264 million. If we subtract that $264 million in expenses from the $3.247 billion in corresponding revenue, we get operating income of $2.983 billion, which corresponds to an operating margin of 91.9%. Hats off to Oracle for a strong quarter overall and particularly in this category of software-license updates and product support (aka "maintenance").

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With the maintenance business performing so spectacularly, how was the profit performance in other parts of Oracle's business? Well, not so good; not so good at all. Now, it might be the case that Oracle chooses to jam all of its discretionary expenses into categories other than maintenance to make it look exceptionally good—but I don't think so.

No, the fact of the matter seems to be that Oracle has developed a maintenance business whose 22% annual fees not only provide all of the company's profits but also cover enormous losses stemming from all other parts of Oracle's business:

Oracle's total quarterly revenue of $5.858 billion, as noted above, included maintenance revenue of $3.247 billion; $1.653 billion from new software licenses; and $958 million from services. So other than maintenace, Oracle's revenue was $2.611 billion.

On the expenses side, Oracle reported total operating expenses for the quarter of $3.68 billion. While Oracle doesn't break out specific expenses for new software licenses or for services, it does for its maintenance business, and that figure was $264 million. So if we subtract that maintenance expense line from Oracle's total operating expenses of $3.68 billion, we come up with $3.416 billion in expenses other than maintenance.

That isolates non-maintenance revenue of $2.611 billion and non-maintenance expenses of $3.416 billion, which leaves a non-maintenance operating loss of $805 million for the quarter. Compare that to the maintenance numbers: $3.247 billion in revenue, $264 million in expenses, operating income of $2.983 billion with an operating margin of 91.9%.

Again, it's entirely possible Oracle structures its financial results in a way to minimize the volume of expenses it associates with its maintenance/support business. But such possible policies aside, the facts within Oracle's own numbers tell us that in in the last three months, Oracle made almost $3 billion from your 22% maintenance fees, and it lost more than $800 million from all other parts of its business combined.

No matter how you choose to parse the accounting, those numbers are absolutely stunning. And that's a reality not lost on Oracle president Safra Catz, who had this to say about the maintenance performance in the Q&A portion of the earnings call with financial analysts:

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