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Oracle Stock Tumbles on Weak 3QFY14 Results; Company to Focus on Software Segment

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By: Larry Darrell
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Oracle Corporation (ORCL), the multinational computer technology corporation based out of Redwood, California, reported its financials for the third quarter (3Q) of its 2014 fiscal year (FY14) after the bell yesterday. It reported per share earnings of 68 cents on revenues of $9.31 billion for the quarter, falling short of Street estimates of earnings of 70 cents on revenues of $9.36 billion.

The company said earnings were lower than anticipated due to the impact of foreign exchange fluctuations on revenues from Venezuela.

Software

The company, which is best-known for its database software offerings, earns a bulk of its revenues (70%) from its Software segment. Within that segment, the company generates 38% of its revenues from licenses for new software and subscriptions for cloud services, and the remaining from software license updates and product support.

Revenues from new software licenses – a key measure of growth for the company, given its business model – grew 4% on a year-over-year (YoY) basis, lower than analysts’ expectations of 5-6% growth. Nonetheless, the 4% increase was a marked improvement compared to the 1% decline reported in the preceding quarter. The company said growth was actually 5% (non-GAAP) if adjusted for exchange rate fluctuations.

Revenues from software license updates and products, on the other hand, grew 5% on a YoY basis to $4.6 billion. Growth in this sub-segment was slightly disappointing, considering the average 6% increase in revenues from this sub-segment in the last five quarters. On a sequential basis, revenues from software license updates and products had grown by a little less than 1%. The sub-segment, which accounted for nearly 50% of the company’s revenues in the reported quarter, is expected to continue growing sluggishly due to the slow pace of growth in sales of new software licenses.

Cloud software subscriptions, which also fall under the company’s Software segment, grew 24% YoY to $292 million, while bookings, yet another sub-segment within the company’s software business, registered 60% growth.

Currently, cloud subscriptions account for 3% of the company's revenues, and have been posting consistent growth; however, a planned transition from the company’s traditional licensing business towards cloud services will create several headwinds for Oracle.

For starters, cloud software revenues are spread over the contract period with a customer, and cloud software does not generate revenues upfront, like Oracle’s licensing business does. Secondly, there are major players already established in the cloud arena – such as salesforce.com (CRM) and Workday Inc. (WDAY) – which will try to block Oracle as it leverages its position to enter the industry. It should also be kept in mind that cloud companies operate at extremely low margins due to their high operational expenses.

Hardware and Engineered Systems

Revenues from the company’s Hardware Systems segment, which have been growing at slower rates in the past few quarters and remained flat in 2QFY14, were up 8% YoY in 3QFY14. Revenues from the segment are also expected to keep rising as the company starts integrating its products into one machine and offering it to consumers at lower costs.

Revenues from Oracle's Engineered Systems segment grew more than 30% YoY during the quarter.

Outlook and Guidance

However, the company will be disregarding strong growth in these two segments to focus on expanding its software business. According to Gartner, Inc. – a technology research and advisory firm – IT spending is expected to increase only 3% this year, whereas spending on cloud services is expected to grow 18%.

Oracle expects revenue growth to range between 3-7% in the ongoing quarter, and to generate around $11.3-$11.7 billion in sales by the time the period is through. The company also said adjusted earnings would be in the range of 92-99 cents per share in the quarter.

On the other hand, analysts had expected earnings of 96 cents a share on revenues of $11.5 billion.

Oracle stock was down 2.7% in pre-market trading today (7:00 AM EST).

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