ORACLE CORP quarterly report, Q3 FY2016

Oracle Corporation Form 10-Q Summary

Business context and reporting period

Oracle provides cloud and on-premise software, hardware, support, and services to more than 400,000 customers worldwide. The filing is for the third quarter and first nine months of fiscal 2016, ended February 29, 2016; the request metadata refers to “2015 Q3,” but the filing period is clearly fiscal 2016.

Oracle’s strategy emphasizes growth in cloud SaaS, PaaS, and IaaS offerings while maintaining its software support base, investing in research and development, and pursuing acquisitions. The company operates through cloud and on-premise software, hardware, and services businesses.

Key financial metrics

Metric	Q3 FY2016	Q3 FY2015	9M FY2016	9M FY2015
Revenue	$9.012 billion	$9.327 billion	$26.453 billion	$27.520 billion
Operating income	$3.027 billion	$3.383 billion	$8.636 billion	$9.889 billion
Operating margin	33.6%	36.3%	32.6%	35.9%
Net income	$2.142 billion	$2.495 billion	$6.087 billion	$7.181 billion
Diluted EPS	$0.50	$0.56	$1.41	$1.59
Net margin	23.8%	26.8%	23.0%	26.1%
Operating cash flow	Not separately provided for the quarter	Not separately provided for the quarter	$9.831 billion	$10.053 billion

Cloud revenue increased to $735 million in Q3 from $527 million, including SaaS and PaaS revenue of $583 million versus $372 million. For the first nine months, total cloud revenue was $1.994 billion versus $1.517 billion.
New software license revenue declined 15% in Q3 and 16% for the first nine months on a reported-currency basis. Software license updates and product support revenue was broadly stable on a reported basis and grew 5% and 6%, respectively, in constant currency.
Hardware revenue declined 13% in Q3 and 11% for the first nine months. Services revenue declined 7% and 5%, respectively, on a reported basis.
Foreign currency movements reduced reported revenue growth by approximately 4 percentage points in Q3 and 6 percentage points for the first nine months. Total revenue grew 1% and 2%, respectively, in constant currency.
Q3 operating expenses were $5.985 billion, up from $5.944 billion; nine-month operating expenses were $17.817 billion versus $17.631 billion. Research and development expense increased to $1.419 billion in Q3 and $4.253 billion for the first nine months.
Interest expense rose 32% in Q3 and 35% for the first nine months because of higher average borrowings following prior debt issuances.
The effective tax rate was 21.6% for Q3 and 21.0% for the first nine months, compared with 20.8% and 21.4% in the prior-year periods.

Financial position, debt, and liquidity

As of February 29, 2016, cash and cash equivalents were $15.583 billion and marketable securities were $35.184 billion, for combined liquidity of $50.767 billion, compared with $54.368 billion at May 31, 2015.
Total debt was approximately $40.1 billion, consisting primarily of non-current senior notes. Oracle repaid $2.0 billion of senior notes at maturity in January 2016.
Working capital was $45.244 billion, down 4% from May 31, 2015. The company stated that available liquidity and operating cash flow should be sufficient for working capital, capital expenditures, contractual obligations, acquisitions, dividends, and share repurchases.
Operating cash flow for the first nine months was $9.831 billion, down 2% year over year. Investing cash outflow was $4.026 billion, compared with $15.323 billion in the prior-year period. Financing cash outflow was $11.689 billion, primarily reflecting share repurchases, dividends, and debt repayment.
Trailing-four-quarter free cash flow was $12.508 billion, down from $13.561 billion. Capital expenditures increased to $1.606 billion from $948 million on the same basis.
Oracle repurchased 222.7 million shares for approximately $8.4 billion during the first nine months and paid $1.918 billion of dividends. On March 15, 2016, the board authorized an additional $10.0 billion of repurchase capacity.

Material changes versus the prior comparable period

Reported revenue decreased 3% in Q3 and 4% for the first nine months, although constant-currency revenue increased 1% and 2%, respectively.
Net income declined 14% in Q3 and 15% for the first nine months; diluted EPS declined 11% and 11%, respectively. Lower earnings reflected weaker reported revenue, higher operating expenses, higher interest expense, and restructuring costs.
Cloud SaaS and PaaS revenue grew substantially, but the shift toward cloud offerings contributed to lower new software license revenue and pressured the cloud software and on-premise software segment margin.
Cloud and on-premise software segment margin fell to $512 million in Q3 from $771 million and to $984 million for the first nine months from $1.869 billion, primarily because expenses increased faster than revenue.
Software license updates and product support remained the highest-margin business, with a 91% segment margin in both Q3 and the first nine months, compared with 90% in the prior-year periods.
Restructuring expense increased to $115 million in Q3 and $293 million for the first nine months, compared with $48 million and $168 million. The Fiscal 2015 Restructuring Plan has estimated total costs of up to $525 million, with approximately $125 million remaining as of February 29, 2016.
Amortization of intangible assets declined to $408 million in Q3 and $1.283 billion for the first nine months, compared with $527 million and $1.642 billion, as certain acquired intangible assets became fully amortized.

Guidance, outlook, commentary, and risks

Management expects cloud and on-premise software revenue to generally increase on a constant-currency basis, supported by cloud demand, recurring software support renewals, and acquisitions.
Oracle expects continued strategic emphasis on cloud SaaS and PaaS growth, which is expected to continue affecting the relationship between cloud revenue and new software license revenue.
Management expects software license updates and product support revenue and margins to grow over the longer term, assuming high renewal rates and continued additions to the support base.
Hardware margins are expected to remain lower than software margins, and quarterly hardware revenue is difficult to predict because of order timing, large transactions, and manufacturing or delivery delays.
Key risks include foreign-currency volatility, competition and technology changes, long and variable sales cycles, customer renewal decisions, acquisition integration, restructuring execution, higher debt and interest costs, tax audits, and potential changes in tax law.
Oracle is defending litigation brought by Hewlett-Packard concerning software support for HP Itanium servers; trial was scheduled to begin May 23, 2016. Oracle stated that it could not estimate a reasonably possible loss range.
Oracle is also defending substantial litigation involving the State of Oregon and Cover Oregon. Trial in the state action was scheduled for January 10, 2017; the company stated that it could not estimate a reasonably possible loss range.
Cash and marketable securities held by foreign subsidiaries totaled approximately $46.8 billion and are considered indefinitely reinvested abroad; repatriation could result in additional U.S. tax.
The filing states that disclosure controls were effective and that there were no material changes in internal control over financial reporting during the quarter.

Important facts for investors to verify

Whether cloud SaaS and PaaS growth continues to offset declines in new software licenses and whether cloud margins improve as scale increases.
The sustainability of software support renewal rates and the effect of acquired deferred-revenue fair-value adjustments on reported revenue.
Completion and final cost of the Fiscal 2015 Restructuring Plan, including the approximately $125 million of estimated remaining costs.
Future capital allocation among share repurchases, dividends, acquisitions, debt repayment, and cloud infrastructure investment.
Debt maturities, interest expense, and the company’s ability to maintain liquidity while funding acquisitions and shareholder returns.
Foreign-exchange effects on reported revenue, earnings, cash balances, and accumulated other comprehensive income.
Developments and potential financial exposure in the HP and Oregon litigation, as well as ongoing tax audits.
The impact of pending accounting standards, particularly revenue recognition and lease accounting, when adopted.