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Oracle Corp. (ORCL - Analyst Report) reported strong fourth quarter 2012 results, with earnings of 79 cents per share beating the Zacks Consensus Estimate by three cents. Strong growth in software sales boosted the earnings.

Earnings (excluding one-time items but including stock-based compensation expenses) increased 8.2% from 73 cents per share in the year-ago quarter. Excluding one-time items and stock-based compensation expenses, non-GAAP earnings stood at 82 cents per share compared with 75 cents per share in the year-ago quarter. This was in the upper range of management’s guided range of 78 cents to 83 cents per share.

Revenues

Total revenue in the reported quarter increased 1.3% year over year to $10.92 billion. The rate of increase was marginally ahead of the low end of management’s guided range of 1.0% - 5.0%. Total revenue also surpassed the Zacks Consensus Estimate of $10.88 billion.

The upsurge was primarily attributed to strong new software license sales, which rose 6.6% year over year to $3.98 billion in the quarter and offset the company’s dismal performance in the hardware segment.

Software license update and product support revenues increased 4.8% to $4.15 billion. As a result, total software revenue (74.5% of the total revenue) climbed 5.7% year over year to $8.13 billion.

Total hardware systems continued to disappoint, with revenues declining 13.8% year over year to $1.58 billion. Revenues from hardware systems products were $977.0 million, down 15.6% year over year, while revenues from hardware systems support amounted to $600.0 million, down 10.8% year over year. The decline in hardware sales was primarily attributed to lower volumes.

Database and middleware revenues were $5.53 billion, up 3.3% from the year-ago quarter. Applications revenues were $2.6 billion, up 11.2% from the year-ago quarter. Service revenues totaled $1.20 billion, which declined 3.7% on a year-over-year basis.

Operating Performance

Operating income on a non-GAAP basis (excluding one-time items but including stock-based compensation expenses) increased 4.4% to $5.31 billion, driven by lower operating expenses. Non-GAAP operating margin surged 140 bps year over year to 48.6% due to the higher-margin software business.

Total operating expenses edged down 1.5% in the quarter, mainly due to lower hardware systems support cost (down 19.7%), hardware systems product cost (down 6.8%), services cost (down 4.5%), Software license updates and product support cost (down 6.6%). This decline was partially offset by a 4.8% rise in research and development cost, a 9% jump in general and administrative cost and a 0.1% rise in sales and marketing cost.

Net income was $3.98 billion (excluding one-time items but including stock-based compensation expenses) compared with $3.74 billion in the year-ago quarter. Net margin expanded 170 basis points (bps) in the quarter.

Liquidity

Oracle generated $13.09 billion in free cash flow, which was 131% of the net income at the end of the fourth quarter. Operating cash flow was $13.74 billion. Oracle had $30.67 billion in cash and marketable securities at the end of the quarter versus $29.74 billion in the previous quarter.

Guidance

For the first quarter, Oracle expects total revenue growth on non-GAAP basis to range from -2.0% to 1.0% considering the current rates. New Software license revenue growth on a non-GAAP basis is expected to between 0% and 10%. Management expects Hardware product revenue to range from -17.0% to -7.0%, excluding the hardware support revenue.

The non-GAAP EPS is expected in the range of 51-55 cents at current rates, up from 48 cents in the prior-year quarter. The Zacks Consensus Estimate for the first quarter 2013 is pegged at 52 cents. GAAP EPS is expected in the range of 37-41 cents.

Recommendation

We believe that Oracle’s strong fourth quarter results will drive the stock going forward. Oracle possesses a strong product pipeline, which will drive broad-based top-line growth going forward.

Moreover, speedy adoption of Exadata, Exalogic, Exalytics, the core SPARC product line and fusion systems will drive incremental top-line growth going ahead. Oracle’s solid product suite lends a competitive edge over rivals like International Business Machines Corp. (IBM - Analyst Report) and SAP AG (SAP - Analyst Report). Additionally, we believe that the new public cloud offering, known as Oracle Cloud, will diversify its revenue base, thereby boosting top-line growth.

However, lower hardware volumes remain a concern in the near term. We believe that Oracle will take at least another three to four quarters to achieve top-line growth in the hardware segment.

As Oracle sells higher-margin products compared to its competitors, we anticipate that a sluggish market and lower IT spending may act as a headwind in the hardware volume going forward. Oracle could see integration issues due to the rapid pace of acquisitions within a short span of time.

We maintain a long-term Neutral recommendation on Oracle. Currently, Oracle has a Zacks #3 Rank, which implies a Hold rating on a short-term basis.

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