Oracle: Preview of Earnings

Oracle Corporation (ORCL) will report third-quarter of fiscal 2010 results after the closing bell today. During its second quarter conference call held on December 17, the company provided better-than-expected third-quarter guidance.

For the third quarter, Oracle expects non-GAAP earnings per share ranging between 36 – 38 cents a share. The Zacks Consensus estimate for the quarter is 36 cents, in line with the company’s guidance. The third quarter EPS estimate is an increase of 5.9% from 34 cents reported in the third quarter of 2009.

We expect the company to report in line or above the Zacks Consensus. Oracle has met or exceeded Consensus expectations in the last two years.

Management expects total revenue to rise between 3% and 6% in the third quarter at the current exchange rates. The guidance assumes a non-GAAP tax rate of 28% versus 26.6% last year. The guidance does not include the impact of the Sun acquisition.

Oracle’s recent results and guidance demonstrate that enterprise and technology spending is on the mend. We are highly positive on the company’s longer term growth prospects and believe that the Sun acquisition will further boost shares. We believe investors will benefit from the company’s growing software business over the long term.

We are highly positive on the company’s growing market share, incremental cost savings and robust cash flow. We provide the following analysis on the company’s last quarter results and its acquisition of Sun Microsystems.

Second Quarter Results

Oracle reported second-quarter earnings that beat the Zacks Consensus Estimate. The market reacted positively to the company’s better-than-expected earnings and growing market share.

Earnings per share of 39 cents were up 15% from the year-ago period of 34 cents, beating the Zacks Consensus Estimate by 4 cents and surpassing the high end of the company’s guidance range of 36 – 36 cents. Net income rose 12.5% to $2.0 billion from the last year. The increase in earnings was due to intensive cost-control measures taken by the company.

Second quarter total sales were up 4.5% year over year at $5.86 billion due to better-than-expected new software license revenue.

Sun Acquisition

Oracle’s recent acquisition of Sun Microsystems will be an impetus to growth in fiscal 2011 and beyond. We expect the increased synergies to strengthen its competitive position as the combined portfolio gains traction. If successful, Oracle’s new strategies would lead to higher top and bottom-line growth.

The acquisition is expected to be accretive to its earnings by at least 15 cents per share on a non-GAAP basis in 2011. The acquired business will contribute over $1.5 billion to Oracle’s non-GAAP operating profit in 2011, increasing to over $2 billion in 2012. Revenue from Sun Microsystems is expected to be $9.6 billion in 2011.

Moreover, the acquisition enabled Oracle to take out its number one competitor, Sun, better positioning it to compete against International Business Machines (IBM), its biggest database software rival, as well as Hewlett-Packard (HPQ), SAP AG (SAP) and Cisco Systems (CSCO).

While Oracle is expected to become the foremost player in the database software market (ahead of IBM) with the acquisition of Sun, we remain concerned about the company’s integration of its former rival. We believe Oracle can drive higher synergies with the acquisition, although the company’s aggressive strategies pose a risk to the stock, with successful execution being the major issue.

Although the third quarter results will not be affected by the Sun acquisition, we are expecting the company to provide a much higher guidance for the combined company, thus lifting expectations for the fourth quarter.

Estimate Revisions

The positive sentiment is also reflected in recent analyst estimate revisions. In the last 30 days, 5 out of a total 18 analysts covering the stock have raised estimates. Moreover, one of these revisions have been in the last 7 days, reflecting growing optimism. Although one analyst moved in the opposite direction, this should not have a major impact on the Zacks Rank.

We believe that the number of positive revisions represents strong agreement among analysts that results are in fact going to improve. For fiscal 2011, 2 analysts have raised their full year numbers in the last 30 days, one of which was made in the last 7 days. This reflects the analysts’ expectations of positive contributions from the Sun acquisition.

Regarding the magnitude of estimate revisions, we fail to see anything meaningful in the last 30 days. While 2010 estimates have not changed at all, 2011 estimates just inched up a penny. But analyst opinion reflected in estimate revisions over the last 60 days shows the Zacks consensus for 2011 moving from $1.69 per share to $1.82 per share.

Recommendation

We remain positive on Oracle’s long-term growth, and expect 2011 results to be strongly aided by the Sun acquisition. However, there will be significant uncertainty surrounding the stock until there is further evidence of a successful integration of the acquisition.

Although very positive on the longer-term prospects, the lack of near-term momentum is what is leading us to maintain a Zacks #3 Rank, which translates to a short-term ‘Hold’ recommendation. Our long-term recommendation for the stock also remains Neutral.