ORACLE CORP quarterly report, Q2 FY2014

Oracle Corporation Form 10-Q Summary

Business context and reporting period

Oracle is a provider of enterprise software, cloud subscriptions, engineered hardware systems, and related consulting, managed cloud, support, and education services. This unaudited Form 10-Q covers the fiscal second quarter and first six months ended November 30, 2013, with comparisons to the periods ended November 30, 2012. Oracle’s fiscal year ends May 31.

Key financial metrics

Metric	Q2 FY2014	Q2 FY2013	Six months FY2014	Six months FY2013
Total revenue	$9.275 billion	$9.094 billion	$17.647 billion	$17.275 billion
Operating income	$3.410 billion	$3.471 billion	$6.283 billion	$6.350 billion
Operating margin	36.8%	38.2%	35.6%	36.8%
Net income	$2.553 billion	$2.581 billion	$4.744 billion	$4.615 billion
Diluted EPS	$0.56	$0.53	$1.02	$0.94
Net cash from operations	Not separately provided for the quarter	Not separately provided for the quarter	$7.438 billion	$6.466 billion

Q2 revenue increased 2% reported and 3% in constant currency; first-half revenue increased 2% reported and 4% in constant currency.
Software revenue increased 4% in Q2 and 5% in the first half. Software license updates and product support revenue increased 6% and 7%, respectively, while new software licenses and cloud subscriptions were flat in Q2 and increased 2% in the first half.
Cloud software subscription revenue increased to $259 million in Q2 from $218 million and to $513 million in the first half from $421 million.
Hardware systems revenue was broadly flat in Q2 but declined 3% in the first half. Hardware systems products revenue declined 3% in Q2 and 9% in the first half, while hardware support revenue increased 4% and 3%, respectively.
Services revenue declined 6% in Q2 and 7% in the first half, primarily from lower consulting revenue.
Q2 net income declined 1%, while first-half net income increased 3%. Lower tax rates supported earnings: the effective tax rate was 20.3% in Q2 and 19.1% for the first half, compared with 21.3% and 22.9% in the prior-year periods.
Cash, cash equivalents, and marketable securities totaled $36.974 billion at November 30, 2013, up from $32.216 billion at May 31, 2013. Cash and cash equivalents were $14.894 billion.
Total borrowings were approximately $24.2 billion, compared with $18.5 billion of senior-note borrowings at May 31, 2013. Current borrowings were $1.525 billion and non-current borrowings were $22.641 billion. Oracle reported compliance with debt covenants.
Working capital was $31.142 billion, up 8% from May 31, 2013. Approximately $31.2 billion of cash, cash equivalents, and marketable securities was held by foreign subsidiaries and considered indefinitely reinvested overseas.
Free cash flow on a trailing four-quarter basis was $14.618 billion, up 14% year over year, representing 132% of trailing four-quarter net income.

Material changes versus the prior comparable period

Operating income declined 2% in Q2 and 1% in the first half despite revenue growth, as operating expenses rose faster than revenue. Reported operating margin declined from 38% to 37% in Q2 and from 37% to 36% for the first half.
Sales and marketing expense increased to $1.965 billion in Q2 from $1.773 billion, and research and development expense increased to $1.273 billion from $1.199 billion, primarily due to higher employee-related costs and headcount.
Q2 acquisition-related and other expense was $17 million versus a $121 million benefit in the prior-year quarter. The first-half comparison was $27 million of expense versus a $380 million benefit, including a $306 million litigation-related benefit and a $129 million contingent-consideration benefit in the prior year.
Oracle acquired companies during the first half of fiscal 2014 for aggregate preliminary consideration of approximately $1.8 billion, recording $923 million of goodwill, $954 million of identifiable intangible assets, and $99 million of in-process research and development. The acquisitions were individually and collectively not material to consolidated results, according to the filing.
Oracle issued €2.0 billion and $3.0 billion of senior notes in July 2013. The proceeds may be used for general corporate purposes, including acquisitions, dividends, and share repurchases.
Oracle repurchased 176.1 million shares for $5.8 billion during the first six months, compared with 200.3 million shares for $6.1 billion in the prior-year period. Approximately $8.3 billion remained available under the repurchase authorization at November 30, 2013.
Dividends paid increased to $1.099 billion from $583 million. The quarterly dividend was $0.12 per share, compared with $0.06 per share in the prior-year quarter.

Guidance, outlook, commentary, risks, and unusual items

The filing does not provide specific quantitative revenue, earnings, or margin guidance. Management expects software revenue generally to increase on a constant-currency basis, supported by support-contract renewals, cloud offerings, acquisitions, and continued investment in research and development.
Management expects software license updates and product support revenue and margins to grow over the longer term, but notes that acquired-contract fair-value adjustments and amortization of acquired intangibles affect reported revenue and margins.
Management expects the hardware business to have lower operating margins than the software business and highlights limited ability to predict quarterly hardware product revenue. A few large orders or delivery delays can materially affect quarterly hardware results.
The Fiscal 2013 Oracle Restructuring Plan has estimated total costs of $705 million. Oracle recorded $99 million in the first half of fiscal 2014 and expected to incur approximately $281 million of remaining costs, largely through the remainder of fiscal 2014.
Future amortization of intangible assets totaled $6.472 billion at November 30, 2013, including $1.086 billion expected during the remainder of fiscal 2014 and $1.807 billion in fiscal 2015.
Key risks include foreign-currency exposure, international operations, acquisition integration and valuation, customer order timing, competition, technology changes, governmental and economic conditions, tax audits, and the ability to renew support and cloud contracts.
A 100-basis-point increase in LIBOR-based rates was estimated to increase annual interest expense by approximately $35 million. A 10% weakening of the U.S. dollar against the euro was estimated to increase the U.S.-dollar obligation associated with the euro-denominated 2025 notes by approximately $101 million.
Oracle stated that it believes current liquidity and operating cash flow are sufficient for working capital, capital expenditures, and contractual obligations, and that future acquisitions, dividends, and repurchases could be funded through cash, operating cash flow, additional borrowings, or securities issuance.
Material legal matters included the SAP intellectual-property litigation, HP litigation concerning software support for Itanium-based servers, and the Pillar Data Systems derivative litigation and related insurance dispute. Oracle stated that it could not estimate a reasonably possible loss for the HP action and did not believe the disclosed matters would result in losses materially exceeding amounts recognized, if any.
U.S. federal and state tax authorities and numerous non-U.S. tax authorities were examining Oracle and acquired entities. Management believes it has adequately provided for reasonably foreseeable outcomes but cautions that actual outcomes are uncertain.

Important facts for investors to verify

Assess whether growth in recurring software support and cloud revenue can offset weakness in new licenses, hardware products, and services.
Reconcile reported earnings with acquisition-related benefits, amortization, restructuring costs, stock-based compensation, and other unusual items.
Monitor leverage, interest expense, refinancing requirements, and sensitivity to LIBOR and foreign-currency movements following the July 2013 debt issuance.
Evaluate the sustainability of share repurchases and dividend growth relative to acquisition spending and debt obligations.
Track the remaining $281 million restructuring estimate and the $6.472 billion of future intangible-asset amortization.
Review acquisition valuations, goodwill of $28.269 billion, preliminary purchase-price allocations, and the risk of future impairment or integration costs.
Follow the HP, SAP, Pillar, and tax matters for changes in expected exposure or cash requirements.
Confirm that cash held by foreign subsidiaries can be accessed economically, given potential U.S. tax consequences upon repatriation.