Oracle Corp.‘s (ORCL) fourth quarter 2010 earnings beat the Zacks Consensus Estimate on the back of strong new software license sales and growth in hardware sales, boosted by the recent acquisition of Sun Microsystems. We believe Oracle’s better-than-expected results were aided by the improving IT spending environment.
Earnings (excluding one-time items but including stock-based compensation expenses) of 58 cents per share were up 31.8% from the year-ago period of 44 cents and 6 cents above the Zacks Consensus Estimate of 52 cents.
Net income rose 30.6% to $2.93 billion from the year-ago period. The rise in earnings was attributable to higher revenues from new software license sales (sales to new customers), which grew for the third consecutive quarter. This shows that demand for software is picking up.
Despite foreign exchange headwinds, Oracle posted record results in the quarter, with revenues coming in at the high end of the company’s guided range. Moreover, the growth in new licensing revenues and earnings per share was very encouraging and remained well above management’s expectations.
Oracle acquired Sun Microsystems in January this year. The company’s quarterly results included a full-quarter contribution from Sun. Oracle’s results reflect the growing importance of its hardware business (acquired from Sun), which generated 19% of total revenue.
Oracle stated that on a stand-alone basis, Sun was profitable in the reported quarter, compared to the loss posted in the year-ago period. Oracle has been cutting costs at Sun by retrenching employees in Europe and Asia, which boosted Sun’s results in the reported quarter.
With the Sun acquisition, Oracle is expected to become the foremost player in the database software market, including high-end servers, and ahead of IBM (IBM), its primary competitor.
Oracle also remained upbeat on its Sun Exadata database machine product. The Exadata portfolio helped Oracle win over IBM’s large customers, such as Bank of America Corp. (BAC) and Carrefour/ Oracle also said that the Exadata product line is making inroads against competitors such as Teradata Corp. (TDC), Netezza Corp. (NZ) and IBM.
Oracle anticipates that the Exadata pipeline will grow to $1 billion in 2011. We believe this will speed up both sales growth and profitability in the Sun server and storage businesses.
Moreover, Oracle stated that it continued to take away market share from SAP AG (SAP). Oracle’s applications business has grown 5% on a constant dollar basis, while SAP’s business has declined 24% from the previous four quarters.
Revenue Details
Total sales in the reported quarter were up 38.5% year over year to $9.51 billion due to better-than-expected new software license revenues. Excluding revenues related to assumed support contracts, which will not be recognized for the remainder of fiscal 2010 and fiscal 2011 due to certain accounting rules, non-GAAP revenues jumped 40% year over year to $9.63 billion.
Oracle is expected to benefit from its growing software business (69% of total revenue), which was robust in the quarter and soared 13% year over year to $6.57 billion. Included in the Software segment, new software license revenues (33% of total revenue) shot up 14% to $3.1 billion and climbed 15% on a constant currency basis. New software license sales were better than the company’s expectation of a growth in the range of 3% to 13%, reflecting substantial strength in Oracle’s database, middleware and software applications business.
Software license update and product support revenues (36% of total revenue) were up 12% to $3.50 billion, and up 11% on a constant currency basis. Customer support attachment and renewal rates were at near record levels in the quarter.
Technology new license revenues came to $2.3 billion, up 18% year over year. Applications for new license revenues grew 6% from last year. Service revenues (12% of total revenue) totaled $1.11 billion, up 4% year over year or 3% on a constant currency basis.
Oracle’s new hardware systems revenues of $1.83 billion represented 19% of the total revenue. Revenues from hardware systems products were $1.2 billion (in line with the company’s expectation), while revenues from hardware systems support amounted to $688 million in the quarter.
Operating Performance
Despite a rise in total operating expenses by 54.9%, operating income on a non-GAAP basis spiked higher by 25.7% to $4.42 billion, aided by increased revenues.
Operating margin of 46% was down 500 basis points year over year. Oracle said that Sun reduced its GAAP operating income by approximately $100 million, including $176 million of amortization, and contributed approximately $400 million to non-GAAP operating income in the quarter. Management said that margins were better than its peers, including IBM and SAP.
The strong results helped Oracle generate $8.5 billion in free cash flow over the last twelve months. Operating cash flow was $8.7 billion on a trailing twelve-month basis. Oracle had $18.5 billion in cash and investments at the end of the quarter versus $17.5 million in the previous quarter.
In the reported quarter, Oracle repurchased 10 million shares for a total of $993 million. Oracle also declared a cash dividend of 5 cents per share.
Guidance
For the first quarter of 2011, Oracle expects non-GAAP earnings per share in constant currency between 36 cents and 38 cents. This is up from 30 cents last year and from 35 to 37 cents assuming current exchange rates. Management said that the pipeline for both software and hardware remains strong.
Assuming current exchange rates, Oracle expects 2% negative currency effect on license growth rates and 3% negative effect on total revenue growth. Total revenue on a non-GAAP basis is expected to range between 41% and 45% in the first quarter at current exchange rates and 44% to 48% in constant currency, less than the 49% expected by analysts. The guidance assumes a non-GAAP tax rate of 28.5%.
New software license revenue growth is expected to range from 4% to 14% at current exchange rates and 2% to 12% in constant currency, implying a range of $1.05 billion to $1.15 billion. Excluding Hardware support revenues, Hardware product revenues are expected to be approximately $1 billion.
Management expects Sun’s acquisition to be accretive to its earnings by at least 15 cents per share on a non-GAAP basis in 2011. Oracle expects Sun to meet or exceed the company’s targets for fiscal 2011 and 2012. The acquired business will contribute over $1.5 billion to Oracle’s non-GAAP operating profit in 2011, increasing to over $2 billion in 2012. Revenues from Sun Microsystems are expected to be $9.6 billion in 2011.
Oracle said that it will no longer be selling products at a loss as Sun did, which means more profit on lower revenues. Oracle also plans to double Sun’s sales force, but did not specify the number of jobs.
Remain Neutral
We believe Oracle is well positioned in the software market. We are positive on the company’s longer-term growth prospects, given its growing market share, new product pipeline, incremental cost savings, robust cash flow, improved margin and incremental benefits from Sun.
However, these positives have already been priced into shares, leaving little room for above-market gains. Moreover, at the current valuation, we believe Oracle’s shares reflect the risks associated with Sun’s acquisition.
Consequently, we are reiterating our long-term Neutral rating on Oracle shares. Oracle is currently rated as a Zacks #3 Rank (‘Hold’), implying that the stock is expected to perform in line with the market.
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