Oracle Hits Its Mark

The software maker meets Wall Street's earnings expectations for its second fiscal quarter by aggressively cutting costs across the board

During the tech industry's last big slump, software and hardware vendors were slow to cut costs as falling demand pummeled profits.

This time around, Oracle (ORCL) isn't taking chances. Oracle, the world's No. 2 software company, hit Wall Street's earnings target when it reported fiscal second-quarter results on Dec. 18, by aggressively cutting research and development, travel, and other costs as its customers curtail spending.

Amid a global economic slowdown that's sapped business demand for computers and software, Oracle widened operating margins in the quarter ended Nov. 30 to 46%, compared with 41.3% a year earlier. While the software maker missed Wall Street's estimates for total sales and new software bookings, its earnings of 34¢ a share, excluding certain items, met analysts' projections. Better still, Oracle issued a third-quarter earnings outlook roughly in line with Wall Street estimates.

Shares of Oracle gained 4% in extended trading, after closing Dec. 18 down 13¢, or 0.8%, at 16.61. The shares have lost 2.4% in the past month, compared with a 4.7% gain for the Nasdaq Composite Index.

Wide Range of Products Helps

Oracle displayed a knack for slicing costs while offering customers a wide range of products that it's assembled through a slew of acquisitions the past four years, analysts said. "This company can hold the bottom line better than anyone," says Brent Thill, Citigroup's (C) software research director, who rates Oracle's stock a buy.

Analysts said Oracle has cut expenses in sales and marketing, and overseas R&D, and reduced sales and back-office expenses from its January acquisition of BEA Systems. A wide breadth of products lets Oracle salespeople zero in on where customers are still spending. "It all goes back to the all-you-can-eat buffet at Oracle," Thill says. "You can pick one thing or everything, and they have something they can talk to a client about."

The appetite for cost-cutting is catching across tech. Dell (DELL) beat Wall Street's profit forecasts in its third quarter, reported Nov. 20, by taking an ax to expenses, despite ringing up sales that were more than $1 billion short of expectations. Troubled computer maker Sun Microsystems (JAVA) in November said it plans to cut up to 6,000 jobs, or 18% of its staff. Tech firms including Adobe Systems (ADBE) and Western Digital (WDC) have announced plans to shed workers as well.

Net Income Falls amid Sales Slowdown

"Within technology we're seeing revenue weakness but good profitability," says Andy Miedler, a senior technology analyst at Edward Jones, who has a buy rating on Oracle. "Companies are more aggressive with cost-cutting during this downturn due to the lessons they learned with cutting costs too slowly during the tech wreck last time."

Cost-cutting aside, sales still take a hit when customers slash information technology budgets. Oracle's net income fell 0.5%, to $1.27 billion, in the second quarter, and sales were up 5.5%, to $5.6 billion, vs. analysts' consensus estimate of $5.84 billion. New software license revenue, an indicator of future sales, was down 3% to $1.6 billion. The closely watched metric fell far short of Oracle's forecast three months ago, when it said new license revenues would rise 2% to 12%. The bookings are a key measure of Oracle's performance, since they often produce additional tech support revenue.

"Customers are signing up for fewer multiyear, $100 million projects," said Chief Executive Larry Ellison during a conference call with analysts. "Fortunately we have a very broad portfolio." A strong dollar is also hurting Oracle's results, as overseas sales translate into fewer dollars on the company's books.

Applications Vulnerable to Downturn

Oracle's bread-and-butter database business is faring better in the recession than its business applications, which companies use to manage finance, HR, sales, and other functions. Sales of new applications licenses fell 15%, to $469 million, during the quarter. Oracle's database and application-connecting middleware license sales grew nearly 4%, to $1.16 billion.

"The applications business is in tough shape," says Citigroup analyst Thill. Applications revenues are more vulnerable in a weak economy, as companies protect database and middleware projects that can yield business information to help them compete, Thill wrote in a Dec. 2 research note. Oracle is locked in an applications market-share battle with SAP (SAP), which in October cut its profitability outlook for the year.

Oracle also issued a downbeat forecast for its third quarter, which ends in February. Assuming today's exchange rates, Oracle said it expects to earn 31¢ to 33¢ per share, vs. Wall Street's expectation of 34¢ per share. Oracle co-President Safra Catz told analysts that the company is expecting a record low in the pace of deal closings for that period of the year.

Lots of Acquisition Candidates

Oracle has been posting bang-up results for the past few years, largely by spending more than $25 billion to buy more than 40 software companies since 2005. In addition to having more products to sell, Oracle can also sign up customers added through acquisitions for lucrative tech-support contracts.

In recent months, Oracle has hinted it may hold to that strategy. There are at least 50 publicly traded software companies with $300 million to $6 billion in annual sales that Oracle could potentially acquire, said Mark Murphy, an analyst at Piper Jaffray (PJC) who rates Oracle a buy, in a Dec. 12 research note. In September, Ellison said Oracle might take advantage of depressed stock prices to buy up more software companies on the cheap.

Now, Ellison said prices have dropped so low that some companies may resist being bought. "Some companies have much more attractive valuations right now, but I'm not sure they'd be wildly enthusiastic about selling for cash [value]," he said on Dec. 18.

When markets rebound and an M&A freeze thaws, Oracle could nevertheless be poised to spring. "As we come out of this cycle, Oracle is extremely well positioned," says Israel Hernandez, a director at Barclays Capital (BCS), who has an overweight rating on Oracle's stock. "They're going to come out a much stronger company after the recession." Until then, Oracle and other tech firms may have to keep looking for costs to chop.

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