Arik Hesseldahl

Recent Posts by Arik Hesseldahl

Oracle’s Sales Fall, Shares Rise: It’s an Upside-Down World

Shares of the software giant Oracle are roaring this morning in the wake of yesterday’s quarterly earnings report, where the headline focus was on smaller-than-expected sales.

While the shares fell in after-hours trading, as markets opened in New York investors sent the share soaring by 68 cents, or more than 2 percent, to $32.94. Profits on a per-share basis were 53 cents, in line with what analysts had expected, while revenue, at $8.2 billion, was off the consensus by about $200 million. What gives? It’s subtle, and it all comes down to two big bets Oracle has made that are close to — but not yet — paying off: Hardware and cloud computing.

First, there’s the hardware business, the remnant of the former Sun Microsystems that Oracle acquired in 2010. Oracle has been rebuilding those product lines into what it calls its “engineered systems” line, hardware sold under the brand name Exa: There’s Exadata, Exalogic and Exalytics. (Oracle president Mark Hurd described them in detail in an interview with AllThingsD in June.) It also sells other lines of hardware, the T and M lines that are leftover Sun products. Here, revenue was $779 million for the quarter.

On a constant currency basis, hardware sales are down by more than 20 percent. As analyst Karl Keirstead of BMO Capital Markets put it, Oracle missed the estimates for hardware sales “by a mile,” and he doesn’t expect it to begin growing until the fourth quarter of the 2013 fiscal year. (Yesterday’s report was for Q1 of fiscal 2013.) In fact, Oracle said that it expects hardware sales next quarter to show year-on-year declines in the range of 8 percent to 18 percent on a constant currency basis.

And yet the shares are rising this morning. For one thing, declining hardware sales are all part of the long-term plan. CEO Larry Ellison has spoken many times of letting lower-margin portions of the hardware business fade away while growing sales of hardware that has a higher margin. That’s what the Exa line is all about. Why sell a bucket of peaches for a $2 profit when you can make peach pie and make a $20 profit? Oracle’s only problem is that its peach pie — that would be the new hardware business — is still getting traction, while the older business selling T-Series and M-Series servers is still hanging around. There was progress: Operating margins rose to 44 percent, up from 42 percent a year ago. Oracle’s goal is to get those margins back to 48 percent, which is where they were before the Sun acquisition.

Analyst Brad Reback of Stifel Nicolaus says the trend may turn in Oracle’s favor by next summer or fall. “We think traction for Oracle’s engineered systems continues to accelerate … However, we believe the ‘bleed off’ of its commodity business and cannibalization of its [higher-priced] M-series is masking strength in these other businesses. We believe by 4Q this trend could reverse and expect growth in its hardware business in FY14.”

Combined with headwinds brought on the by the strength of the U.S. dollar versus several foreign currencies, especially the euro, the miss in hardware essentially dragged down the rest of the business. It certainly could have been worse.

Meanwhile, Oracle made a lot of noise about its burgeoning business of offering applications in the cloud, or on a “software-as-a-service” basis. Remember that Oracle has been spending big on cloud acquisitions in the last year or so, nabbing the HR software firm Taleo and the customer support company RightNow, among others. Keirstead reckons that those deals added 11 percent to Oracle’s top line on a constant currency basis.

The new embrace of the cloud constitutes a pivot toward a second fundamental transition. Oracle has long been one of the leaders in the old-school “on-premise” type of software that runs internally on a company’s hardware. Cloud software runs in remote data centers and is generally sold on a subscription basis, where the customer pays for what they use.

Of the $1.6 billion in new software-license and cloud-subscription revenue, return derived from cloud software amounted to $222 million. Its biggest success in the cloud appears to be in the HCM (Human Capital Management) space, which would include the Taleo acquisition. It said less about its Customer Relationship Management suite, which Keirstead thinks suggests that Oracle is getting serious pressure on that front from

Whatever the case, CEO Larry Ellison said that more cloud announcements are coming at Oracle’s annual OpenWorld conference in San Francisco next month. “Oracle has clearly signaled that it is pivoting to the cloud more assertively, which may reassure investors worried that it was late in doing so,” Keirstead wrote in a note to clients this morning. For now, the Street likes the cloud.

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