Enterprise software giant Oracle (click ticker for report: ) announced results for the third quarter of its 2013 fiscal year. Revenue fell 1% year-over-year to $9 billion, falling short of consensus estimates. Earnings per share rose 5% year-over-year to $0.65, just a penny shy of consensus expectations.
Given the amount of noise in sales and earnings per share, our favorite metric to evaluate is free cash flow, which remained fantastic at $9.2 billion year-to-date. Oracle’s cash balance now sits at $34.2 billion, giving the company tremendous flexibility to make acquisitions or return cash shareholders. The firm’s non-GAAP operating margin totaled 47%, an increase of 17 basis points compared to the same period a year ago.
On the segment side, Oracle struggled mightily with hardware, where sales of systems dipped 22% year-over-year to $671 million. According to President Mark Hurd, sales of the M-Series server drove weakness. We think there may have been some hesitation on the part of consumers to purchase new M-Series products in light of the launch and delivery of the new M5, which CEO Larry Ellison noted is 10x faster than the old model at the same cost. The firm had previously targeted the fourth quarter of fiscal year 2013 as the inflection point, but Ellison pushed the turnaround back to the first quarter of fiscal year 2014. We remain cautious on Oracle’s hardware offerings until we see signs of a turnaround.
On the software side, revenues for the total segment grew 4% year-over-year to $6.7 billion. Oracle cited fantastic SaaS cloud growth as one of the main growth drivers during the quarter, and Ellison noted that the business is now a $1 billion in sales. In aggregate, cloud revenue fell 1% year-over-year to $238 million. Given Oracle’s massive sales force hiring (4,000 in the past 18 months), we’re anticipating stronger sales growth going forward.
Looking ahead, Oracle guided to revenue growth of -1% to +4%, falling below the consensus expectation of 5.2% growth. We think the low guidance for revenue is mostly the product of a weak hardware outlook, as the firm believes segment sales will fall 12% to 22%. On the other hand, Oracle anticipates software sales growing 1% to 11%. On the earnings side, Oracle guided to $0.85-$0.91 per share in non-GAAP earnings, up slightly from 2011’s $0.82, and in-line with consensus expectations.
Overall, it appears the hardware market is going through more headwinds than the company previously anticipated. Fortunately, we believe Oracle’s capital management and large cash balance give the firm plenty of flexibility to make an acquisition or simply repurchase shares—which it did to the magnitude of $2.1 billion during the third quarter. Ellison may receive overly generous compensation, but we believe his focus to make Oracle the premier enterprise solutions company is nearly unmatched. Shares trade at the low end of our fair value range, and a further pullback could tempt us to add shares to the portfolio of our Best Ideas Newsletter.