Oracle (NYSE:ORCL) investors were not happy when the company posted its fiscal fourth-quarter 2014 results that showed that its net income had dropped. Oracle's lower profit can be chalked up to its heavy investments in the cloud arena. CEO Larry Ellison chimed in with a cloud note saying that the company had now become the No. 2 SaaS company with Salesforce in the lead.
Oracle's SaaS and PaaS subscriptions grew 25% to $322 million, much faster than the company's overall revenue growth.
But, Oracle now has one more reason to smile. Its long-suffering hardware segment is now sputtering back to life, powered by strong growth in the company's engineered systems.
Oracle is platform king
IDC released first-quarter fiscal 2014 engineered systems numbers that showed that Oracle's integrated platform revenue grew at a 24% clip to reach $369 million. Integrated platform is a subset of engineered systems, with integrated infrastructure being the other subset. IDC defines the two in the following manner:
- Integrated platforms-- these are engineered systems that come with pre-integrated packaged software as well as customized systems engineering that is optimized to enable functions such as databases, app development, testing, and integration tools.
- Integrated infrastructure--these are systems that are designed for general purpose and distributed workloads. Unlike their integrated platform brethren, integrated infrastructure systems are not optimized for specific workloads.
Meanwhile, Cisco (NASDAQ:CSCO) is the integrated infrastructure king. The company's FlexPods joint venture with NetApp grew 49.8% year-over-year to reach $268.4 million in the first-quarter of 2014. Not surprisingly, Cisco server revenue grew by the fastest clip among all major vendors in fiscal 2013--38.7%. Cisco came into the server business in 2009 around the same time that Oracle did, and the two companies' overall server revenues are almost identical.
EMC (NYSE:EMC) posted the most impressive growth after its integrated infrastructure revenue grew 100.2% to reach $179.9 million during the first-quarter.
Declining hardware business
Oracle's revenues from its server division have been trending south ever since it bought out Sun Microsystems. Just prior to its acquisition, Sun Microsystems reported revenues of $12 billion and $9 billion in fiscal years 2008 and 2009. These revenues included sales and services of servers and related hardware. The business has continued to decline under Oracle, and the segment posted revenues of $7 billion, $6 billion, and $5 billion in server sales and services for fiscal years 2011, 2012, and 2013, respectively.
Oracle's hardware business has been plunging much faster than the overall server market, which declined 4.4% in 2013.
Oracle's huge decline in server sales is actually by design and not by accident. The software developer's main goal when buying out Sun Microsystems was to acquire Sun's powerful software platforms such as Java and Solaris, and get a hold of Sun's high-end customers.
Oracle moved out of the low margin x86 server business and shut down the OpenSolaris project to concentrate on rebranding Solaris as a fully featured Unix-based system. The firm then focused on rebuilding Sun Microsystem's RISC microprocessor platform so as to compete better with the Unix platforms of market leaders such as IBM's PC-based AIX systems and HP's UX systems.
Oracle has also moved into engineered SPARC servers which command higher margins. Although the ASP of these high-end servers is much higher than that of commodity x86 servers, the total volumes of shipments has been declining due to the global server weakness.
High-margins engineered systems good for cloud growth
Oracle's integrated platform systems are not only growing much faster than the low-end server business, but also command much better margins. For instance, HP has a heavy exposure exposure to the traditional server business and, as a result, commands a much lower corporate gross of margin 25% compared to Oracle's 80%. The annual revenue run rate of Oracle's engineered systems is now equal to that of its cloud business.
The SaaS revenue model that Oracle is banking on is, ironically, the same reason why its profit has come under pressure lately. SaaS companies invest very heavily in sales and marketing functions so as to quickly grow their customer base and reduce customer churn.
Oracle spent about 23% of revenue as marketing expenses in 2014, after its sales and marketing expenses grew 6% during the year. In comparison, most SaaS companies spend close to half of their revenue, or more, on sales and marketing expenses. This makes it very hard for many SaaS companies to turn a profit. None of the SaaS companies mentioned here is profitable, including Salesforce, which has been in business for around 10 years.
Foolish bottom line
Oracle's rapidly growing high-margins engineered systems will go a long way in absorbing some of its swelling marketing costs as the company continues to expand its SaaS business. That's great news for the company and investors.