Software developer Oracle (NYSE:ORCL) reported its Q2FY14 (ending November 30, 2013) earnings on December 18, after the market closed. Revenues for the quarter increased 2% to reach approximately $9.3 billion, slightly ahead of the industry consensus of $9.19 billion.(Fiscal years end with May.) However, weak performance in the three quarters prior to Q2FY14, weighed down on CY2013 revenue growth for the company. Calendarized revenues for 2013 rose to $37.7 billion vs. $37.2 billion a year ago, representing a meager 1.3% year-on-year growth.
Despite registering a decent growth in its Q2 earnings, operating margin witnessed a slight contraction for the quarter. Oracle’s GAAP operating profit margin stood at 37% for the three months ending November 30, 2013, compared to 38% from a year prior period. We believe the contraction was a result of an expansion in sales and marketing, and R&D expenses to support Oracle’s new product pipeline. GAAP net income margin for the quarter was flat compared to Q2FY13 at approximately 28%. However, earnings per share grew 5% as the company continued with its strong share repurchase program this quarter. For the next quarter, Oracle guides GAAP earnings to range between 54 – 58 cents per share, which is in line with Street expectations.
In the current article, we highlight key takeaways from the recent Q2 earnings which could be influential for Oracle’s future top line growth.
New Software License Sales Continue To See No Growth
Oracle’s software business includes the sale and renewal of On-premise and On-demand products such as databases, applications and other middleware products. Revenues for the entire software division, which includes both On-premise and cloud subscription revenues, showed momentum during the quarter with a growth rate of New license revenues for the quarter were flat from a year prior period, at approximately $2.4 billion. Cloud-based software bookings grew a robust 35%. For the entire CY2013, new product license revenues expanded 0.65% to reach approximately $10.4 billion compared to $10.3 billion in CY2012. New license revenue growth rate in prior calendar years was much higher, at 17% in CY2010 and CY2011 and 9% in CY2012.
We believe multiple macroeconomic as well as company specific factors have resulted in a deceleration in new license revenue growth rate for Oracle. The weak IT environment has forced small businesses to defer their plans of buying new software products. Additionally, Oracle’s relatively slow cloud adoption could have forced its customers to choose providers such as International Business Machines (NYSE:IBM) and SAP AG (NYSE:SAP) who have taken an earlier, more aggressive stance in migrating to cloud. Going forward, we expect softness in demand for Oracle’s software products in the near term as Oracle continues to progress in its cloud adoption. Below, we highlight Oracle’s presence in the Asia-Pacific market, which is expected to see strong growth in the future. On the flipside, Oracle’s constant innovation and consistent product launches and updates within its database management system division could continue to provide meaningful growth for the software division. Oracle has yet to see reasonable contribution arising from its newest 12c database, which could provide impetus to the slowing new license revenues. 
Weak Hardware Products Sales Weigh On Overall Revenues
Oracle has seen a decline in hardware revenues since its acquisition of Sun Microsystems in CY2010. The enterprise server market has been tough for all participants,even as Oracle has worked to re-position Sun’s offering. During the current calendar year, hardware system revenues dropped almost 14% to $2.9 billion as Oracle struggled to manage the decline of older products with the growth of the newer systems that are intended to replace them. However, this drop in sales is lower than the 20% decline seen in CY2012. Oracle states that Engineered Systems now account for 30% of overall hardware system sales, and are beginning to contribute to an slow turnaround in the division.  While Oracle’s Engineered Systems reported double digit growth of 34% in bookings, its SPARC SuperCluster and BigData Appliance products witnessed triple digit growth rates in Q2FY14.  Furthermore, the company launched a new aggressively-priced server offering, Oracle Virtual Compute Appliance that targets mass deployments, using Linux-based low-end servers and leveraging Infiniband, rather than Ethernet, as the connect technology. This is a significant expansion of its offering.
In sum, the company has worked hard to reposition its hardware business, even as demand for its high-end products has fallen. Once this market stabilizes and demand for high-end systems recovers, the company could well do better. We currently forecast Oracle’s market share in the Enterprise Server market to continue declining as competition from major players like Hewlett Packard (NYSE:HPQ) and IBM intensifies.
Asia-Pacific Revenues Continue To Decline
During the six months in fiscal 2014, Oracle’s revenues from the Asia-Pacific region decreased 12% to reach approximately $1 billion in revenues. Divisionally, both software license revenues as well as hardware system revenues registered negative growth rates during the period. However, the larger new license division posted a steeper year-over-year decline in revenue in Q2FY14 compared to the smaller hardware systems division. New software license revenues from Asia Pacific declined 17% on a year-over-year basis as opposed to 5% decline for Q1FY14. Hardware systems witnessed an opposite trend in the two quarters, with a 15% year-over-year decline in Q1FY14 and a 10% drop in the subsequent quarter.
The Asia-Pacific market accounts for approximately 17% of Oracle’s revenues, and top line erosion in a high growth, high potential market such as Asia could be a significant drag on Oracle’s future. Within the Asia-Pacific market, Oracle has a larger footprint in countries like Japan and Australia where growth is stabilizing. In the future, Oracle could leverage the potential of markets like India, China, Singapore and Malaysia by expanding its current infrastructure base within these regions. On the flipside, strengthening developed markets of the U.S. and Europe could offset any decline in revenues from smaller markets like Asia-Pacific because of their higher technology adoption rate.
We are in the process of updating our $42 Trefis price estimate for Oracle, which stands nearly 21% above its current market price.Notes:
- Oracle’s Management Discusses F2Q 2014 Results – Earnings Call Transcript, Seeking Alpha, December 2013 [↩] [↩] [↩]