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Oracle Corp. (ORCL - Analyst Report) reported earnings of 53 cents per share in the first quarter of 2013. Including stock-based compensation of $193.0 million (4 cents per share), earnings were 49 cents per share, which missed the Zacks Consensus Estimate by 2 cents.

Quarter Details

Total revenue in the reported quarter decreased 2.3% year over year to $8.21 billion. Revenue fell slightly short of the consensus mark and also missed the management’s lower end of the guided range of (2.0%) - 1.0% growth forecast.

The weak revenue growth was primarily due to lackluster performance from the hardware and services segment in the quarter, which fully offset higher software revenue.

Software revenue climbed 3.7% year over year to $5.74 billion, primarily driven by 6.3% jump in new software license sales (slightly better than the mid-point of the management’s guided range of 0% to 10%) and 2.7% increase in software license update and product support revenues.

Cloud revenue was $222.0 million in the quarter. The company added a number of new customers in both customer relationship management (“CRM”) and human capital management (“HCM”) portfolios. This includes Accenture (ACN - Analyst Report), Adobe (ADBE - Analyst Report), Barnes & Noble (BKS - Snapshot Report), Cisco (CSCO - Analyst Report), Colgate-Palmolive (CL - Analyst Report), Proctor & Gamble (PG - Analyst Report) to name a few.

Hardware declined 19.5% year over year to $1.36 billion, primarily due to a massive 24.3% plunge in hardware systems sales and 11.9% decline in hardware system support revenue. However, engineered systems (Exadata, Exalogic, Exalytics) continued to grow at triple digit rates. Oracle added a number of new customers during the quarter.

Services revenue declined 5.6% year over year to $1.11 billion in the reported quarter.

Total operating expenses declined 3.7% from the year-ago quarter to $4.80 billion. All expense items, except research & development expense (“R&D”), declined significantly in the quarter, reflecting stringent cost control. R&D surged 14.4% annually in the quarter.

Operating income (excluding one-time items of $792.0 million but including stock-based compensation expenses of $176.0 million) remained flat year over year at $3.41 billion. Operating margin expanded 90 basis points due to lower operating expenses.

Net income was $2.61 billion or 53 cents per share compared with $2.47 billion or 48 cents in the year-ago period. Earnings were within the company’s guided range of 51 cents to 55 cents per share.

Liquidity

Oracle exited the first quarter with cash and marketable securities of $31.61 billion compared with $30.67 billion at the end of the previous quarter. GAAP operating cash flow was $13.99 billion compared with $13.74 billion in the previous quarter.

Free cash flow of $13.37 billion ($13.10 billion in the previous quarter) was impressive providing ample liquidity to Oracle in order to pursue acquisitions, sustain dividend payments and further share repurchase. Oracle bought back 104.2 million shares for $3.1 billion in the quarter.

Guidance

For the second quarter of 2013, Oracle expects non-GAAP earnings in the range of 59 cents to 63 cents per share, which is significantly higher than the year-ago level. Currently, the Zacks Consensus Estimate is pegged at 59 cents, in line with the low end of the guided range.

Total revenue on a non-GAAP basis is expected to grow in the range of 0.0% to 4.0% (in $). New software license and cloud subscription revenue growth is expected to range from 5.0% to 15%. Hardware product revenue is expected to be in the range of (18%) to (8%) in the reported quarter.

Recommendation

Oracle started fiscal 2013 on a disappointing note. However, we believe that the company’s strong product pipeline will drive broad-based top-line growth going forward. We believe that speedy adoption of engineered systems and cloud suites will drive incremental top-line growth going ahead. Oracle’s solid product suite lends a competitive edge over rivals like IBM Corp. (IBM - Analyst Report) and SAP AG (SAP - Analyst Report).

However, lower hardware volumes remain a concern in the near term. 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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