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California woes cloud Oracle's quarter

Timing is everything--and for Oracle, the controversy over its $95 million contract with the state of California couldn't have come at a worse time.

Timing is everything--and for Oracle, the controversy over its $95 million contract with the state of California couldn't have come at a worse time.

Already combating sluggish sales in a weak economy, the database giant may now find that fallout from the California contract is causing some potential customers to delay signing any last-minute deals. As a result, according to potential buyers and analysts, Oracle is offering unusually steep discounts.

"I've talked to organizations who are much more hesitant--who would have gone through with these deals at substantial discounts but now say they're going through the process of due diligence," said Meta Group analyst Mark Shainman. "There has been some turmoil in the relationship, and (the customers) said, 'We're not going to be pressured.'"

The combination of a sputtering economy, rising competition and the expanding California scandal threatens to become the financial equivalent of the perfect storm for Oracle.

Many companies rely heavily on deals signed in the waning days of a quarter, and Friday marks the end of Oracle's fourth quarter and 2002 fiscal year. The company's California deal, for example, was signed exactly one year ago at the end of the 2001 fiscal year.

Concerns about that contract exploded into national headlines last month, after California auditors said the no-bid, multiyear, statewide deal could have ended up costing California $41 million beyond what it is currently paying. The deal is now being unwound, although financing details are proving tricky to untangle.

"The Department of Justice, Fish and Game and other departments will be watching Oracle (on this matter) and saying, 'Who is this business partner?'" said Dean Florez, chairman of the California Joint Legislative Audit Committee, which is conducting an investigation into the deal.

And that could be just the beginning. "This will have a ripple effect that (Oracle CEO) Larry Ellison will have to look at," Florez added. "If they don't handle it right (with us), it will reverberate up to federal agencies, and they'll begin to question the business partner they have in Oracle."

Oracle representatives declined to comment.

Bernard Soriano, chief information officer for the California Secretary of State's office, said he plans to take a more cautious approach when dealing with Oracle in the future.

"Anytime you have a company that is in the news, one would naturally tend to be more wary, especially when you have a renewal of an existing contract or a new contract with that company," Soriano said. "You want to make sure all the i's are dotted and t's are crossed. We're already careful, but we would take extra care to make sure we are thorough."

The IT department for the Secretary of State's office has a $5 million budget for fiscal 2002. It uses Oracle's database software for such tasks as voter registration, the notary system, and the campaign and lobbying reporting system.

Oracle's sales efforts have come under scrutiny and embroiled Gov. Gray Davis, who is up for re-election in November. Oracle gave a $25,000 campaign contribution to a Davis aide--several days after the state signed its contract with the company. Davis has since returned the contribution.

Unusual discounts
Traditionally, Oracle has given customers who sign contracts worth more than $2 million discounts of 60 percent to 75 percent off "retail price," analysts say. California was given a 60 percent discount to arrive at the $95 million price tag, for example.

Reports coming in from this fiscal year's close have cited considerably higher discounts. A Montana official said his state was offered discounts of up to 85 percent. Analysts, including Shainman, said other customers are being offered discounts as high as 90 percent--and more frequently than in the past. Smaller contracts, too, are being offered handsome discounts.

One of Shainman's clients signed a $1.2 million deal and was given a 65 percent discount. A traditional "list" discount for something that small would have been closer to 25 percent, he said.

Meanwhile, Oracle has approached the state of Montana with an 85 percent discount, provided the Big Sky state would be willing to renegotiate its five-year statewide license deal now, two years before it is scheduled to end, said Tony Herbert, the state's deputy chief information officer.

These discounts might actually persuade many customers to sign up by the close of business Friday, despite lingering skepticism over the California imbroglio. But that could spell bad news for Oracle's bottom line in years to come.

"In the short term, this could help," said John Meyer, an analyst at research firm Giga Information Group. "In the long term, this could have a very negative impact on them."

Rick Sherlund, an analyst at investment bank Goldman Sachs, agreed that there was concern that Oracle could be setting itself up for having "overcapacity," or too much software, in the market--reducing the need for companies to make additional purchases anytime soon.

"There is a confluence of events: Not only do you have a tough market, but also IBM is increasingly competing with Oracle at the high end and Microsoft at the low end," Sherlund said. "Oracle will be in a difficult position for a while. There's a concern they will burn up the market with overcapacity."

Competition looms
The company's revenue has fallen for the past four quarters when compared with year-over-year figures. For the first nine months of the fiscal year, Oracle generated $6.8 billion in revenue--down from $7.6 billion during the same period last year. When it closes out the current year, most analysts don't expect the company to surpass the $10.9 billion in revenue it generated last fiscal year.

IBM and Microsoft, meanwhile, have picked up market share, with IBM even unseating Oracle at the top of the database management software market for the first time, according to one research firm.

The Toronto police department was one public agency that switched from Oracle database software to IBM in the midst of a contract meltdown between the city of Toronto and Oracle.

Toronto is trying to extract itself from an $11 million citywide Oracle contract, which a city auditor's report called a "serious miscalculation," as it apparently included 10 times the amount of software licenses the city needed. Meanwhile, the Toronto police department has sought approval to sign a $3.9 million, five-year license for IBM's DB2 software.

That decision was based on scrapping the department's existing Oracle software, because it would have had to pay $10.8 million for the Oracle bid--making the IBM offer far cheaper, even when transition costs were included, the city auditor's report noted.

Although publicized instances of out-and-out switches like this remain rare, analysts are keeping an eye on whether Oracle's competitors will use the California controversy as an opportunity to swoop in and snag government business away from the company.

But John Chen, chief executive of competitor Sybase, said he does not expect a surge in new business. He noted that the situation surrounding the California contract is somewhat rare--a large, no-bid contract that was rushed forward in record time.

"Doing business with the government is rather straightforward," Chen said. "So it won't likely create new opportunities for us that weren't already there."'s Dawn Kawamoto contributed to this report.