(ORCL) Oracle Reports Strong Fourth Quarter Earnings Results

Oracle Corp. (ORCL) reported an impressive fourth quarter 2011, with quarterly revenues surpassing $10.0 billion for the first time in the company’s history. The robust top-line growth helped Oracle earn 71 cents per share in the quarter, which beat the Zacks Consensus Estimate by two cents.

Operating Performance

Net Income was $3.68 billion (excluding one-time items but including stock-based compensation expenses) or 71 cents per share compared with $2.87 billion or 56 cents in the year-ago period. Net income margin expanded 430 basis points (bps) in the quarter.

Excluding one-time items and stock-based compensation expenses, non-GAAP earnings came in at 75 cents per share compared with 60 cents per share in the year-ago quarter. This was above management’s guided range of 69 cents to 73 cents per share.

The increase in earnings was attributable to higher revenues from new software license sales, which grew for the seventh consecutive quarter and is expected to drive higher revenues from support and maintenance contracts going forward. This also reflects upside in software demand.

Total operating expenses increased 6.6% in the quarter, mainly due to increased research and development expenses (10.8% of the total revenue) that rose 10.1% to $1.17 billion and sales and marketing expenses (19.4% of the total revenue) that climbed 20.2% to $2.09 billion.

Despite higher expenses, operating income on a non-GAAP basis increased 19.5% to $4.98 billion, driven by strong revenue growth. Non-GAAP operating margin of 46.2% surged 290 bps year over year, driven by the higher margin software business.

Although hardware revenues declined in the quarter, hardware gross margin increased to 55.8% compared with 45.7% in the prior-year quarter. This essentially reflects a shift in Oracle’s policy to selling Sun products at a higher profit margin rather than selling them at a loss or reselling products from other companies. We believe that operating margins will benefit from declining percentage of third party hardware reselling (non-Sun) going forward.

Revenues

Total revenues in the fourth quarter increased 12.2% year over year to $10.81 billion, driven by better-than-expected new software license revenues (up 19.2% year over year), which fully offset a decline in hardware sales (down 4.0% year over year).

Oracle is expected to benefit from its growing software business (71.4% of fourth quarter revenues), which was robust across all regions (America, EMEA and Asia) and up 16.8% year over year to $7.71 billion.

Beside higher new software sales, software license update and product support revenues (36.8% of the total revenue) grew 14.7% to $3.98 billion.

Database and middleware revenues were $5.36 billion, up 16.7% from the year-ago quarter. Applications revenues were $2.34 billion, up 18.4% from the year-ago quarter. Service revenues totaled $1.25 billion, up 12.6% year over year.

Oracle’s Hardware Systems revenues of $1.84 billion represented 17.1% of the total revenue. Revenues from hardware systems products were $1.16 billion, down 6.2% year over year, while revenues from hardware systems support amounted to $687.0 million, flat year over year.

The decline in hardware sales were primarily attributed to Oracle’s policy of selling Sun products at a profit, thereby cutting down on volume. We also believe that lower IT spending in the quarter, due to the sluggish macro environment in the Europe/Middle East/Africa (EMEA) market, may have also contributed to this decline. Hardware revenue declined 13.0% in EMEA, compared to a 3.0% decline in the Americas and 4.0% decline in the Asia Pacific.

Liquidity

Strong quarterly results helped Oracle generate $10.76 billion in free cash flow, which was 126% of the net income. Operating cash flow was $11.21 billion in the quarter. Oracle had $28.85 billion in cash and marketable securities at the end of the quarter versus $24.36 billion in the previous quarter. In the reported quarter, Oracle repurchased 12.5 million shares for a total of $422 million.

Guidance

For the first quarter of 2012, Oracle expects non-GAAP earnings in the range of 45 cents to 48 cents per share. First quarter 2012 earnings guidance is significantly higher than the 39 cents reported in the comparable quarter last year as well as the Zacks Consensus Estimate of 44 cents.

Total revenue growth on a non-GAAP basis is expected to range from 9.0% to 12.0%. New software license revenue growth is expected in the 10.0% to 20.0% range. Hardware product revenue growth is expected to range from (5.0%) to 5.0% for the first quarter.

Recommendation

We believe that Oracle will continue to report strong results based on its innovative product pipeline, improving margins, high recurring revenues, strong growth from Exadata and Exalogic and increasing adoption of cloud computing over the long term.

Moreover, Oracle is expected to pick up significant market share from SAP AG (SAP) in the Applications market going forward. Oracle is also expected to edge out its prime competitor IBM Corp. (IBM) in the database market.

According to research firm Gartner, Worldwide IT spending is estimated to total $3.6 trillion in 2011, a 5.1% increase from 2010. Of this, computing hardware and enterprise software are each expected to witness year-over-year growth of 7.5%.

We believe Oracle will benefit from this trend, as it remains well positioned with Sun hardware and Oracle software. The fact that both the Sun hardware and Oracle software are relatively higher-margin is an added bonus. Hence, we believe that the company will hugely benefit from these products going forward.

Additionally, Sun holds the promise of even more returns if Oracle is able to win the lawsuit against Google Inc. (GOOG) over its Android operating system.

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.

However, Oracle is expected to face strong competition from Hewlett Packard Co. (HPQ), IBM, Cisco Systems Inc. (CSCO) 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) Outperform recommendation on Oracle shares. Currently, Oracle has a Zacks #2 Rank, which implies a Buy rating on a short-term basis.

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