Oracle (NYSE:ORCL) is scheduled to report its fiscal second quarter results on December 18. (Fiscal year ends with May). In the previous quarter, Oracle posted a 2% expansion in its top line as software revenues picked some momentum. However, Hardware and Service revenue growth for the company remained soft. For the current quarter, we expect software revenues to continue boosting overall top line modestly for the company. Demand for Oracle’s hardware products is expected to remain soft in the near term as the company continues to overhaul lagging products with its newer Engineered Systems. Service revenues, which are often tied to implementation of the company’s products, are dependent both on underlying product sales and the macroeconomic IT environment. In the current environment, demand for services is not that strong.
Q1 FY14 non-GAAP operating profit stood at approximately $3.7 billion, increasing 6% over Q1FY13. The faster increase in operating profit compared to revenues facilitated a 90 basis point expansion in operating profit margins for the quarter. Non-GAAP earnings registered an even faster growth rate of 12% to reach 59 cents per share for the quarter, boosted by a comparatively lower tax rate of 22%.
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In terms of guidance for Q2, Oracle expected revenues to grow by (-1%) to 2% in U.S. dollar terms. Net income for Q2 is expected to be between 64 – 69 cents per share, indicating a sequential growth of 8% – 17%.  In this article, we discuss key factors that will influence its upcoming Q2 results. We currently have a $42 Trefis price estimate for Oracle, which stands nearly 21% above its current market price.
Enterprise Software Solutions Poised For Strong Growth In 2013
Well known technology research firm Gartner reiterated its growth forecast for the Worldwide IT spending last quarter due to the recent fluctuations in U.S. dollar exchange rates. The market research firm expects global IT spend to be approximately $3,723 tillion, with a revised growth forecast of 2% against its previous estimate of 4.1%.  However, enterprise software solutions are expected to grow faster this year, with a growth rate of 6.4% against 4.7% in 2012, to reach $304 billion.  Gartner reports that enterprise software sales are expected to outpace the global IT spending growth as a result of greater penetration of Customer Relationship Management (CRM) software into the e-commerce and social networking.
These prospects of higher growth in enterprise software solutions across the world should continue to boost Oracle’s software revenues. The company derives approximately 72% of its overall revenues from the software division, which comes to $27 billion in annual revenues. Last quarter, Oracle witnessed a 6% expansion in its software revenues. However, growth in revenues from software updates and product support outpaced new license revenues at 7% vis-a-vis 4% as business continued to hold back on IT investments.
We expect similarly strong growth patterns in overall software revenues this quarter. Deferred revenues for Oracle’s software updates and product support increased 24% in Q1FY14 over Q4FY13 and stand at $7.07 billion as of August 31, 2013. This indicates a very strong order pipeline for the short term. In comparison, deferred revenues for new licenses declined 15% to $278 million during the same period as Oracle fulfilled its existing order pipeline. In the current quarter, we would be closely monitoring Oracle’s growth in new software licenses, which serves as the bellwether for the global IT industry, and its new software license deferred revenue levels.
Business Focus Should Shift Towards Asia-Pacific For Further Cloud Subscription Growth
Revenue shares from the Americas, EMEA and Asia-Pacific regions have changed from 52%, 32% and 16% in 2010 to 54%, 29% and 17%. However, this increase in share for the Asia-Pacific region for Oracle in an indirect impact of an overall increase in IT spending in the region. Business spending on enterprise software solutions in the Asia-Pacific region grew at double-digit pace in 2012, and this trend is expected to continue in 2013 with a surge in demand from strong emerging markets of India and China, followed by Malaysia and Singapore. Gartner expects the total spend on enterprise software in India to grow 14.5% and reach $3.96 billion in 2013. 
While the increase in IT spending in the Asia-Pacific region boosts revenues for all software vendors, we believe that Oracle’s limited footprint in the region has resulted in constrained growth from the region. Oracle operates only one data center out of Australia for the entire Asia-Pacific region, and growing demand for cloud-based enterprise software solutions means the company has to up the ante with its cloud migration. According to a recent Gartner report, growth in the $131 billion public cloud services market is expected to be driven by smaller economies of Indonesia, Greater China, India and Latin America in 2013.  Given its leading position in database, middleware and application software products, Oracle could tap into the vast potential of the cloud services market in the Asia-Pacific region by expanding its data center base.
Margins To See Short Term Pressure As Cloud Adoption Intensifies
Oracle has leveraged its leadership position across various software products over the years with higher product pricing, and has long benefited from the on-premise software model. However, in recent times, intensifying cloud competition and tremendous success from Salesforce.com (NYSE:CRM) and Workday have negatively impacted Oracle’s position in the enterprise software market. This increasing competition across various Enterprise Resource Planning (ERP), CRM and Human Capital Management (HCM) software products led to a a decline in operating margins due to an increase in investments from Oracle to retain its position in the market. Going forward, we expect margins to see downward pressure as Oracle continues its cloud product rollout. In the long term, however, margins would benefit from the higher revenue recognition and lower operational expenses offered by a subscription model as opposed to a perpetual license.
We will be revising our price estimate of $42 for Oracle once the company files its results with the SEC.Notes:
- Oracle Management Discusses Q1 2014 Results – Earnings Call Transcript, Seeking Alpha, September 2013 [↩]
- Gartner Says Worldwide IT Spending on Pace to Reach $3.7 Trillion in 2013, Gartner Newsroom, July 2013 [↩] [↩]
- Gartner Says India Enterprise Software Market To Reach $3.96 Billion In 2013, Gartner Newsroom, October 2013 [↩]
- Gartner Says Worldwide Public Cloud Services Market to Total $131 Billion, Gartner Newsroom, February 2013 [↩]