Oracle Corp. (ORCL) reported modest first quarter 2012 results, with earnings of 46 cents per share beating the Zacks Consensus Estimate by two cents. Total revenue was slightly above the Zacks Consensus Estimate of $8.34 billion.
Earnings per share (excluding one-time items but including stock-based compensation expenses) increased 14.6% from 40 cents in the year-ago quarter. Excluding one-time items and stock-based compensation expenses, non-GAAP earnings came in at 48 cents per share compared with 42 cents per share in the year-ago quarter. This was in line with the high end of management’s guided range of 45 cents to 48 cents per share.
The increase in earnings was attributable to higher new software license sales, which grew for the eighth consecutive quarter. The focus on software is expected to drive higher revenues from support and maintenance contracts going forward.
Operating Performance
Operating income on a non-GAAP basis (excluding one-time items but including stock-based compensation expenses) increased 21.3% to $3.42 billion, driven by strong revenue growth and lower-than-expected increase in operating expenses. Non-GAAP operating margin surged 360 bps year over year to 40.7%, driven by the higher-margin software business.
Oracle’s policy of selling Sun products at a higher profit margin rather than selling them at a loss or reselling products from other companies paid off in this quarter, as hardware product margin increased to 54.1% compared with 48.4% in the prior-year quarter.
Total operating expenses jumped 4.4% in the quarter, mainly due to higher sales and marketing expenses (up 22.3% to $1.63 billion or 19.4% of the total revenue) and general and administrative expenses (up 14.3% to $311.0 million or 3.7% of the total revenue) arising from higher rate of hiring.
Net Income was $2.36 billion (excluding one-time items but including stock-based compensation expenses) compared with $2.03 billion in the year-ago period. Net income margin expanded 130 basis points (bps) in the quarter.
Revenues
Total revenue in the reported quarter increased 10.7% year over year (just above the mid-point of management’s guided range of 9.0% – 12.0%) to $8.40 billion, driven by better-than-expected new software license revenues (up 16.5% year over year), which fully offset a decline in hardware sales (down 4.2% year over year).
Oracle is expected to benefit from its growing software business (66.0% of first quarter revenues), which was robust across all regions (America, EMEA and Asia) and up 16.2% year over year to $5.5 billion.
Besides higher new software sales, software license update and product support revenues (48.0% of the total revenue) grew 16.1% to $4.04 billion.
Database and middleware revenues were $3.78 billion, up 16.2% from the year-ago quarter. Applications revenues were $2.34 billion, up 17.3% from the year-ago quarter. Service revenues totaled $1.18 billion, up 10.4% year over year.
Oracle’s Hardware Systems revenues of $1.69 billion represented 20.1% of total revenue. Revenues from hardware systems products were $1.03 billion, down 4.6% year over year, while revenues from hardware systems support amounted to $656.0 million, down 3.5% year over year.
The decline in hardware sales were primarily attributed to Oracle’s policy of selling Sun products at a profit, which had a negative impact on volume. We also believe that lower IT spending in the quarter, due to the sluggish macro environment prevailing in both the U.S. and Europe/Middle East/Africa (EMEA), may have also contributed to this decline. A modest 2.0% increase in the EMEA and a healthy 6.0% increase in the Asia-Pacific failed to offset a hefty 12.0% hardware revenue decline in the Americas.
Liquidity
Oracle generated $8.47 billion in free cash flow, which was 133% of the net income in the first quarter. Operating cash flow was $8.76 billion. Oracle had $31.66 billion in cash and marketable securities at the end of the quarter versus $28.85 billion in the previous quarter. In the reported quarter, Oracle repurchased 27.5 million shares.
Guidance
For the second quarter of 2012, Oracle expects non-GAAP earnings in the range of 56 cents to 58 cents per share. Second quarter 2012 earnings guidance is significantly higher than the year-ago level of 49 cents per share as well as the Zacks Consensus Estimate of 54 cents.
Total revenue growth on a non-GAAP basis is expected to range from 4.0% to 8.0%. New software license revenue growth is expected in the 6.0% to 16.0% range. Hardware product revenue growth is expected to range from flat to down 5.0% in the second quarter.
Recommendation
Oracle is scheduled to release a number of new products in the second quarter. The new products include the fault tolerant SPARC Supercluster, featuring its new T4 microprocessor, which is 5 times faster than the T3 microprocessor currently in use. The other products are the Solaris 11 operating system and Exadata Flash disk storage system.
We believe Oracle has a strong product pipeline, which will drive broad-based top-line growth going forward. Moreover, strong adoption of Exadata, Exalogic, the core SPARC product line and fusion systems will drive incremental top-line growth going forward.
We expect this strong product portfolio will provide Oracle a competitive edge over International Business Machines Corp. (IBM) and SAP AG (SAP), going forward. We particularly note that Oracle’s Applications business posted 63.0% growth in the EMEA region during the reported quarter, which indicates that Oracle is gaining significant market share as compared to SAP in the region.
Currently, less than 10.0% of global IT spend is on cloud computing. According to market research firm In-Stat, businesses in the United States will spend more than $13 billion on cloud computing by 2014. Oracle, through its Exadata and Exalogic product lines, provides the infrastructure for companies to adopt cloud computing, where data is handled remotely in datacenters rather than on premises.
Oracle is gradually exiting the low-margin third-party hardware sales business, which will drive its margin growth going forward. The company remains focused on selling SUN products at high margins, which will drive operating profit going forward.
However, lower hardware volume will remain a concern in the near term. We believe Oracle will take at-least another three to four quarters to achieve top-line growth in the hardware segment. This is particularly due to the uncertain macro environment in both the Americas and EMEA. As Oracle sells high margin products compared to its competitors, we believe a sluggish market and lower IT spending may hurt its hardware volume going forward.
Oracle is also expected to face strong competition from Hewlett Packard Co. (HPQ), IBM, VMware Inc. (VMW) and Red Hat Inc. (RHT) in the cloud computing market that may hurt its profitability over the long term.
We maintain a long-term (6–12 months) Neutral recommendation on Oracle shares. Currently, Oracle has a Zacks #3 Rank, which implies a Hold rating on a short-term basis.
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