Oracle Sings an Old Lament

Its database segment looks solid, the applications business less so.
By Bill Snyder ,

Updated from 8:06 a.m. EST

After nearly two years of sound and fury,

Oracle's

(ORCL) - Get Report

first post-PeopleSoft quarter turned out to be the same old story -- solid performance in the core database business, weighed down by poor execution on the application side.

The mixed performance drew a somewhat tentative reaction from Wall Street. In recent trading Wednesday, shares of Oracle were off a penny to $12.48.

"It was a solid quarter, but the glaring blemish was the application business. Not only was PeopleSoft's contribution poor, the execution on the Oracle side was poor as well," said Loomis Sayles analyst Tony Ursillo. But he added: "I'll give them a pass this quarter since the deal was closed in it. I'll look to the May quarter as a better commentary on what they have been able to do." (Both Loomis Sayles and Ursillo hold Oracle shares.)

The database giant reported third-quarter earnings late Tuesday that beat expectations by a penny a share. It also saw revenue rise by 23% to $3.09 billion and raised guidance for the rest of the year. Oracle also accomplished at least one major goal: growing new license revenue in its core database business by 12%, including a much stronger showing for its most advanced database products.

But the success of its $10.6 billion acquisition of PeopleSoft was less clear, in large part because PeopleSoft contributed revenue only for two seasonally weak months. Moreover, Oracle's struggling applications business actually shrank by about 15% year over year, when PeopleSoft's $31 million contribution is backed out.

On a GAAP basis, which includes various items related to the company's acquisition of PeopleSoft, the database giant earned $540 million, or 10 cents a share, compared with last year's earnings of $635 million, or 12 cents a share. Excluding those costs, the company earned $814 million, or 16 cents a share.

Revenue on a GAAP basis was $2.95 billion, while total non-GAAP revenue increased 23% to $3.09 billion for the quarter. Wall Street was expecting a 15-cent-a-share profit on revenue of $3.074 billion.

"We are extremely pleased that third-quarter non-GAAP net income was up 25%, and non-GAAP earnings per share was up 28%," said Safra Catz, Oracle's co-president and interim CFO. "Given our strong Q3 results and the improved outlook for Q4, we are raising our non-GAAP EPS guidance for the full fiscal year 2005 from 62 cents to 64 cents to 65 cents."

Wall Street was anticipating a profit of 63 cents a share.

For the fourth quarter, the company expects to earn a pro forma 22 cents to 24 cents a share on revenue ranging from $3.84 billion to $3.97 million. Analysts polled by Thomson First Call were projecting a 22-cent profit with revenue of $3.87 billion.

On a GAAP basis, the company expects to earn 17 cents to 18 cents a share on revenue ranging from $3.66 billion to $3.79 billion.

Probably the most closely watched number was PeopleSoft's contribution to application licenses. Estimates by Wall Street analysts varied widely, with some as low as $15 million or $20 million and at least one as high as $90 million. The number came in at $31 million, bringing the total application license revenue to $152 million, up 9% from $140 million a year ago.

Oracle CEO Larry Ellison admitted that PeopleSoft's contribution was on the light side, but said that PeopleSoft had "bled its pipeline dry" in its previous quarter as it attempted to fight off Oracle's takeover. Additionally, there was some disruption to Oracle's application software sales staff when the two companies were integrated. It will take several quarters to get past those growing pains, Ellison said.

It's worth noting, though, that Oracle's total applications revenue, which includes ongoing maintenance and support, was $851 million, an increase of nearly 48%.

Rob Tholemeier, an independent strategist who has followed the software market for years, urged investors to view ongoing revenue as a key business metric. "In other words, the biggest part of the software business is also the fastest growing, the most sustainable, and the most profitable, but few people have actually caught on," he said.

License updates and supports grew from $237 million to $351 million in the quarter, including a $230 million contribution from PeopleSoft.

"The integration of PeopleSoft took a toll on margins, but had less of an effect than we had expected," said Richard Williams, chief software analyst for Garban Institutional Equities. Gross margin fell to 77.0% vs. 78.6% last quarter, and operating margin dropped to 37.6% vs. 41.0%.

In a conference call after the announcement, Catz said, "We are still marching toward our goal of a 40% operating margin." The company expects to hit that target by the end of the year, despite the ongoing PeopleSoft integration. (Garban does not hold Oracle.)

Getting its money's worth out of PeopleSoft will be key to boosting Oracle stock, which is off 8% this year, amid some feeling that Oracle paid too much for its rival -- and may have paid too much for

Retek

(RETK)

. Oracle

snagged Retek Tuesday morning after a brief bidding war with

SAP

(SAP) - Get Report

over the retail-industry software maker.

At current prices, Oracle is trading at about 17 times 2006 earnings estimates, which many analysts -- but not all -- consider too low. UBS analyst Heather Bellini, for example, whose company has a banking relationship with Oracle, has a price target of $18.50 a share; Williams says Oracle's earnings have been inflated by currency fluctuations and has a target of $9 per share.

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