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Sun grows Oracle but stunts profits

The ups and downs of acquisition

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All eyes were on Wall Street this afternoon as software giant and new hardware vendor Oracle reported sales of $6.4bn for its third quarter of fiscal 2010 ended in February, up 17 per cent from the year ago period. However, thanks to its $7.4bn acquisition of Sun Microsystems, which happened a month before the end of the quarter, Oracle booked $34m in acquisition costs and had $306m in restructuring charges and that helped push net income down 10 per cent to $1.19bn.

The way accounting gets done in this crazy world, for the next four quarters the revenues that are derived from the Sun acquisition will allow Oracle to show double-digit growth even though its core software and related support business is only growing in the single digits. If you ignore the $273m in hardware systems sales and $185m in hardware systems support revenues that Oracle booked from the Sun division in its fiscal Q3, Oracle's core sales were only up 7 per cent in fiscal Q3.

New software license sales (again excluding Sun) were up 10 per cent, to $1.7bn. New software license sales from Sun came to $46m, Oracle said on a conference call with Wall Street analysts. Software license updates and product support sales in the quarter rose by 13 per cent, to $3.3bn. Non-GAAP operating income was up 13 per cent, to $2.9bn (excluding Sun), and non-GAAP net income was up 9 per cent, to $1.9bn.

Across all hardware products, Sun accounted for $596m in total sales, which is $273m for hardware, $244m for support, and the remaining $79m for other services.

In the fiscal third quarter, the Oracle hardware business had $206m in operating expenses, and the related hardware support business had $116m in operating expenses. That means in the one month that Oracle had Sun on its books, 24.5 per cent of the hardware money and 37.3 per cent of the support money related to Sun hardware hit the middle line. This is perhaps better than many expected.

In Oracle's fiscal Q4, Sun should contribute roughly three times this amount of revenues - and perhaps more. Consider that the relief that many Sun shops had that the IBM-Sun-Oracle soap opera was finished when the deal finally closed on January 26 - and that the March through June quarter is traditionally a strong one for Sun because it was its own fiscal year end.

In a statement accompanying the results, Oracle co-president Safra Catz said that the Sun integration "is going even better than we expected" and added that Oracle believed "Sun will make a significant contribution to our fourth quarter earnings per share as well as meet the profitability goals we set for next year."

In the call, Catz said that even with Sun included in the mix, Oracle's operating margins were at 45 per cent, and she reiterated that Oracle was on track to get $1.5bn in non-GAAP operating income from the Sun division in fiscal 2011 and $2bn in fiscal 2012.

There are a number of reasons why Oracle thinks it can do for Sun what Sun could not do for itself. For one thing, as El Reg has already reported in the wake of the Oracle takeover of Sun in January, Oracle has switched the Sun products from a build-to-stock to a build-to-order model, which means there's no inventory to pay for and stock and therefore pay for again.

Oracle has also ditched products that Sun was selling, sometimes at a loss, and it's walking away from deals where the margins are low - particularly in the HPC space, where Sun was bleeding red ink on deals to try to get traction. The Oracle sales force, now including Sun people, is being compensated on both revenues and margins on Sun server and storage sales.

Oracle's other president, Charles Phillips, said that the company was forecasting that it would have $100m in Exadata V2 database cluster systems sales in the fourth quarter and that it has a sales pipeline for the machines that is approaching $400m. The company did not elaborate on how much of the hardware sales in fiscal Q3 came from the Exadata V2 boxes, which were announced using Sun x64 blades and storage arrays and Oracle database and storage software last September, well after Oracle thought the Sun acquisition that was announced last April would have closed and well before it did.

After closing the Sun deal and winning the America's Cup race, Oracle chief executive officer, Larry Ellison, has the smug turned up past 11 all the way to 13. "Every quarter we grab huge chunks of market share from SAP," Ellison said in the statement accompanying Oracle's financials. "SAP's most recent quarter was the best quarter of their year, only down 15 per cent, while Oracle's application sales were up 21 per cent. But SAP is well ahead of us in the number of CEOs for this year, announcing their third and fourth, while we only had one."

"We really think that SAP has lost its way, and if they don't want to be number one, we do," Ellison said in the conference call. Ellison said that Oracle would deliver its Fusion applications both on premise and as a service over the Web this year, something the company can do because it is built on Java and has rich industry functionality. SAP, by contrast, said Ellison, is based on the ABAP language, a 25-year-old technology that is at the heart of its application software, and SAP is not keeping pace with industry-specific functions. "We think SAP is vulnerable and we can take them on in a number of industries," Ellison said.

Looking ahead, Catz said that Oracle expects hardware sales to be in the range of $1.2bn and $1.3bn in the fiscal fourth quarter. The company did not provide hardware support figures, and there is no per cent given because Oracle didn't own Sun in the prior year's quarter.

Oracle expects new software license sales to rise by anywhere from 3 to 13 per cent, and overall revenues to grow by 36 to 41 per cent, thanks in large part to a full quarter of Sun sales but also a bit from organic growth. Oracle is nonetheless expecting for earnings per share in Q4 fiscal 2010 to be between 37 and 41 cents, which is a lot better than the 24 cents per share it booked in fiscal Q3. ®

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