Oracle Corp. (ORCL) reported better-than-expected second quarter of fiscal 2014. After consecutively missing for the last three quarters, the company finally succeeded in beating the Zacks Consensus Estimate for revenues in the reported quarter.

Hardware revenues (in terms of $) were flat with the year-ago quarter, a much improved performance. Although new software license sales declined marginally (in terms of $), considering tough year-over-year comparisons (18.0% growth in the year-ago quarter) the result was commendable.

Most significantly, engineered systems continued to gain traction as bookings growth was approximately 35.0%. Cloud bookings also jumped 35.0% during the quarter. Management provided optimistic third-quarter revenue guidance.

Oracle reported earnings of 69 cents per share, which increased 7.8% year over year. However, adjusting for stock-based compensation, earnings were actually 66 cents per share, couple of cents better than the Zacks Consensus Estimate.

Revenues

Revenues increased 2.0% year over year to $9.28 billion in the first quarter of fiscal 2014. Unfavorable currency negatively impacted revenues by 1.0% in the quarter. The year-over-year growth was toward the higher end of management’s guided range of (1.0%)–2.0% growth.

Software revenues (74.3% of revenues) increased 3.5% year over year to $6.90 billion, primarily driven by a 6.0% increase in software license update and product support revenues. New software licenses and cloud software subscription revenues declined marginally.

In cloud, Oracle achieved strong growth in all major products, including Fusion SaaS. Human Capital Management (:HCM), Sales Automation and Enterprise Resource Planning (:ERP) bookings grew by triple digits in the quarter.

The company added a number of new clients in HCM, which includes the likes of British Telecom, Siemens North America and PPG Industries.

Hardware revenues of $1.33 billion were flat on a year-over-year basis, much better than management’s guided range of 11.0% to 1.0% decline. Unfavorable currency negatively impacted revenues by 2.0% in the quarter.

The improvement was primarily due to a 3.9% year-over-year growth in hardware systems support revenues. Hardware systems products declined 2.7% year over year to $714.0 million.

Engineered systems (Exadata, Exalogic, Exalytics, Big Data Appliance, SPARC SuperCluster) customer base continued to grow in the quarter. Engineered Systems now account for 30% of hardware revenues.

Oracle added a number of new clients such as All Nippon Airways, Live Nation, Tesco, Washington Post and Procter & Gamble (PG) in the quarter

Services revenues declined 6.0% year over year to $1.06 billion in the reported quarter.

Geographically, the Americas grew 4.3% year over year, primarily driven by strong performance in Latin America. Europe, Middle East and Africa (:EMEA) increased 4.3% from the year-ago quarter. Asia Pacific declined 9.0% year over year, due to weak performance in Japan and Australia.

Margins

Total operating expenses as a percentage of revenues increased 100 basis points (bps) from the year-ago quarter to 56.2%. Sales & marketing (S&M), research & development (R&D) and Services jointly incurred 78.3% of the operating expenses in the quarter.

S&M and R&D expenses increased 170 bps and 50 bps, respectively, on a year-over-year basis in the quarter. The year-over-year growth in S&M expense reflects Oracle’s growing sales personnel base. However, services as a percentage of revenues declined 100 bps from the year-ago quarter.

Operating margin contracted 100 bps on a year-over-year basis to 43.8%, primarily due to higher operating expenses. Net income margin declined 30 bps on a year-over-year basis to 32.6% in the quarter.

Liquidity

Oracle exited the second quarter with cash and marketable securities of $36.97 billion compared with $39.10 billion at the end of the previous quarter. GAAP operating cash flow was $15.20 billion compared with $14.85 billion in the previous quarter.

Free cash flow of $14.62 billion ($14.18 billion in the previous quarter) was impressive, providing ample liquidity to Oracle in order to pursue acquisitions, sustain dividend payments and further share repurchase. Oracle bought back 83.4 million shares for $2.8 billion in the quarter.

Guidance

For the third quarter of 2014, Oracle expects non-GAAP earnings in the range of 68 to 72 cents per share. Currently, the Zacks Consensus Estimate is pegged at 67 cents, slightly below the low-end of guided range.

Revenues on a non-GAAP basis is expected to grow in the range of 2.0% to 6.0% (in $). New software license and cloud subscription revenue growth is expected to range from 1.0% to 11.0%. Hardware product revenues are expected to be in the range of (2.0%) to 8.0% in the upcoming quarter.

Our Take

Oracle’s second-quarter results provided a sigh of relief to its investors as it reflected that management’s turnaround initiatives are working. We believe that the speedy adoption of engineered systems and cloud suites will drive incremental top-line growth, going ahead.

Oracle’s low cost engineered systems (Oracle Virtual Compute Appliance) are also expected to attract price-sensitive customers in the long run. However, the company will face significant competition from Cisco (CSCO) in this market.

Although government IT spending is expected to remain muted, improving macroeconomic environment in the Americas and EMEA is expected to boost enterprise spending in the remainder of 2014. This will also boost Oracle’s top-line growth, going forward.

Geographically, Asia-Pacific is expected to remain a headwind, particularly due to broad macroeconomic issues in Australia and New Zealand, despite strong anticipated growth in China.

Moreover, higher subscription revenues are expected to provide a recurring high margin revenue base, going forward. Additionally, improvement in sales force hiring rate will continue to boost bookings. However, this may hurt margin expansion in the near term.

Further, stiff competition from the likes of International Business Machines (IBM) remains a major headwind in the near term.

Currently, Oracle has a Zacks Rank #3 (Hold).

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