Oracle's Negative Surprise Underlines A Surprising Volatile Model
Software giant Oracle (Nasdaq:ORCL) has always marched to the beat of its own drummer, and that willingness to go its own way has always been a big driver of the company's success. It doesn't come without a cost, though, as Oracle is also surprisingly volatile on a quarter-to-quarter basis when compared to other large tech companies like IBM (NYSE:IBM), Microsoft (Nasdaq:MSFT), and SAP (NYSE:SAP).
For the company's fiscal third quarter, that volatility swung in a very negative direction. While the shortfall may well have been due to a combination of revenue pulled forward into the surprisingly strong fiscal second quarter (as customers finished spending on 2012 budgets) and weak sales execution, investors are likely to take it as a referendum on the near-term health of the tech sector. More patient investors, though, may want to use an opportunity like this to build a position in a company that, while erratic, is also a strong performer with an interesting valuation.
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A Bad Quarter All Around
There wasn't much good news from Oracle this quarter. While the gross margin was pretty solid and Exadata looks healthy, that was about it.
Revenue fell 1% from last year on a reported basis (and fell 2% sequentially), with constant currency performance coming in flat. Software license revenue was down 2% and missed the average sell-side guess by about 9%. Hardware was also incredibly weak – the company followed up a 23% decline in fiscal Q2 and a 24% decline in fiscal Q1 with a 23% decline this quarter. Service revenue also declined 8%, while software maintenance revenue improved 7%.
Oracle's gross margins were solid, increasing nearly two points on a non-GAAP basis with the lower hardware contribution. Operating income (also non-GAAP) declined about 1%, while the company still maintained an operating margin above 46%. On a GAAP basis, the operating income rose 1% with an operating margin of 37%.
Management Isn't Panicking
Although Oracle management didn't try to pretend that this was a strong quarter, the company also didn't indicate that they believed this quarter's underperformance fundamentally changes the near-term outlook. Management mentioned poor sales force execution (in particular, lower close rates), and that could be a byproduct of recent sales force expansions and/or timing. Likewise, it's well worth asking whether the very strong fiscal second quarter effectively robbed this quarter of revenue and profits.
There's still reason for cautious optimism at Oracle. Exadata revenue was strong (up 82% on a year-over-year basis) and should continue to be a big driver in calendar 2013. The weaker hardware results from companies like IBM, Hewlett Packard (NYSE:HPQ), and Dell (Nasdaq:DELL) can't (and shouldn't) be wholly ignored, but Oracle still has the opportunity to grow this business.
Likewise, there's still a case to be made for ongoing growth in Oracle's large software business. Sales execution is now very much on the table as a risk factor, and investors are likewise right to be concerned as to whether this weak performance means that the overall IT sector has slowed. That said, management was pretty optimistic about the pipeline, and there's nothing so far about Oracle's performance that is out of line with the overall theme of “weak first half, stronger second half” for 2013 that we've heard from so many companies through the recent earnings cycle.
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The Bottom Line
It may be true that investors have grown bored with themes like Big Data and cloud, and investors should not completely discount the risk that enterprises have already bought what they need. On the other hand, I'd be careful about counting Oracle out at this point, as most surveys and independent research reports support the fundamental notions of strong underlying demand in middleware, database, and other key Oracle markets.
The good news for investors is that expectations for Oracle are not all that robust anyway. Long-term growth of 4% to 5% supports a price target above $41, and with the likely post-earnings drop in the stock Oracle will start to look like a relative bargain again.