Oracle Reports Strong 3Q

Zacks

Oracle Corp. (ORCL) reported strong third quarter 2012 results, with earnings of 59 cents per share beating the Zacks Consensus Estimate by four cents. The earnings beat resulted from strong growth in software sales.

Earnings per share (excluding one-time items but including stock-based compensation expenses) increased 14.4% from 52 cents in the year-ago quarter. Excluding one-time items and stock-based compensation expenses, non-GAAP earnings stood at 62 cents per share compared with 54 cents per share in the year-ago quarter. This was well above management’s guided range of 55 cents to 58 cents per share.

Revenues

Total revenue in the reported quarter increased 2.9% year over year to $9.06 billion. This was within the management’s guided range of 1.0% - 5.0%. Total revenue also surpassed the Zacks Consensus Estimate of $9.03 billion. The upsurge was primarily attributed to strong new software license sales, which rose 7.1% year over year to $2.37 billion in the quarter.

Software license update and product support revenues (46.0% of the total revenue) also grew a healthy 8.3% to $4.07 billion. As a result, total software revenue (69.0% of the total revenue) climbed 7.9% year over year to $6.44 billion.

Hardware systems continued to disappoint with revenues declining 12.5% year over year to $1.48 billion. Revenues from hardware systems products were $869.0 million, down 16.0% year over year, while revenues from hardware systems support amounted to $610.0 million, down 7.0% year over year. The decline in hardware sales was primarily attributed to lower volumes. Oracle also stopped selling certain third party products which had a negative impact on hardware sales.

Database and middleware revenues were $4.49 billion, up 9.6% from the year-ago quarter. Applications revenues were $1.93 billion, up 4.1% from the year-ago quarter. Service revenues totaled $1.14 billion, flat on a year-over-year basis.

Operating Performance

Operating income on a non-GAAP basis (excluding one-time items but including stock-based compensation expenses) increased 7.5% to $4.05 billion, driven by lower operating expenses. Non-GAAP operating margin surged 200 bps year over year to 44.7% due to the higher-margin software business.

Total operating expenses inched down 0.6% in the quarter, mainly due to lower general and administrative expenses (down 8.7%), hardware systems product cost (down 8.8%) and hardware systems support cost (down 12.6%), which offset a higher sales & marketing expense (up 5.1%) and a moderate increase in research & development cost (1.6%).

Net income was $3.02 billion (excluding one-time items but including stock-based compensation expenses) compared with $2.67 billion in the year-ago period. Net margin expanded 290 basis points (bps) in the quarter.

Liquidity

Oracle generated $12.95 billion in free cash flow, which was 133% of the net income at the end of the third quarter. Operating cash flow was $13.46 billion. Oracle had $29.74 billion in cash and marketable securities at the end of the quarter versus $31.01 billion in the previous quarter. In the reported quarter, Oracle repurchased 59.1 million shares.

Guidance

For the fourth quarter of 2012, Oracle expects non-GAAP earnings in the range of 78 cents to 83 cents per share. Fourth quarter 2012 earnings guidance is significantly higher than both the year-ago level and the Zacks Consensus Estimate of 73 cents per share.

Total revenue on a non-GAAP basis is expected to grow in the range of 1.0% to 5.0%. New software license revenue growth is expected to range from 1.0% to 11%. Hardware product revenue is expected in a band of $870.0 million to $980.0 million for the fourth quarter.

Recommendation

We believe that Oracle’s strong third quarter results will drive the stock going forward. Besides, Oracle possesses a strong product pipeline, which will drive broad-based top-line growth going forward. Moreover, speedy adoption of Exadata, Exalogic, Exalytics, the core SPARC product line and fusion systems will drive incremental top-line growth ahead. Oracle’s solid product suite lends a competitive edge over rivals like International Business Machines Corp. (IBM) and SAP AG (SAP).

However, lower hardware volumes remain a concern in the near term. We believe that Oracle will take at least another three to four quarters to achieve top-line growth in the hardware segment. As Oracle sells higher-margin products compared to its competitors, we apprehend that a sluggish market and lower IT spending may further hurt its hardware volume going forward.

We maintain a long-term (6–12 months) Neutral recommendation on Oracle. Currently, Oracle has a Zacks #3 Rank, which implies a Hold rating on a short-term basis.

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