Oracle Corporation: Fiscal 2019 First-Quarter Form 10-Q
Business Context and Reporting Period
Oracle provides applications, platform and infrastructure technologies through cloud, on-premise and hybrid deployment models. Its three operating businesses are cloud and license, hardware, and services. This unaudited Form 10-Q covers the three months ended August 31, 2018, the first quarter of fiscal 2019, compared with the three months ended August 31, 2017. Fiscal 2018 comparative results were recast for the full-retrospective adoption of ASC Topic 606, Revenue from Contracts with Customers.
Key Financial Metrics
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Total revenue | $9.193 billion | $9.104 billion | 1% reported; 2% constant currency |
| Cloud services and license support revenue | $6.609 billion | $6.407 billion | 3% |
| Cloud license and on-premise license revenue | $867 million | $894 million | (3%) |
| Hardware revenue | $904 million | $943 million | (4%) |
| Services revenue | $813 million | $860 million | (5%) |
| Operating income | $2.778 billion | $2.749 billion | 1% |
| Operating margin | 30% | 30% | Flat |
| Net income | $2.265 billion | $2.144 billion | 6% |
| Diluted EPS | $0.57 | $0.50 | 14% |
| Effective tax rate | 10.8% | 14.2% | Lower |
| Cash flow from operations | $6.722 billion | $6.566 billion | 2% |
Net margin was approximately 24.6%, compared with approximately 23.6% in the prior-year quarter. Interest expense increased to $529 million from $469 million, primarily due to higher average borrowings. Net non-operating income increased to $291 million from $220 million, mainly because of higher interest income.
At August 31, 2018, cash and cash equivalents were $18.455 billion and marketable securities were $41.639 billion, for total cash, cash equivalents and marketable securities of $60.094 billion. Working capital was $47.447 billion. Current and non-current notes payable and other borrowings totaled approximately $58.129 billion, including $3.743 billion current and $54.386 billion non-current.
Operating cash flow was supplemented by $3.532 billion of investing cash inflows, largely from maturities and sales of marketable securities. Financing activities used $13.333 billion, including $9.967 billion for share repurchases, $742 million for dividends and $2.5 billion for debt repayments. Cash declined by $3.165 billion during the quarter to $18.455 billion.
Trailing four-quarter free cash flow was $13.896 billion, calculated as $15.542 billion of operating cash flow less $1.646 billion of capital expenditures. This is a non-GAAP measure and is not a quarterly free cash flow figure.
Material Changes Versus the Prior Comparable Period
- Cloud and license revenue increased 2% reported and 4% in constant currency, driven primarily by growth in cloud services and license support and contributions from acquisitions.
- Hardware revenue declined 4% reported and 3% in constant currency as Oracle emphasized cloud-based infrastructure technologies and experienced lower product and support sales.
- Services revenue declined 5% reported and 4% in constant currency, primarily because of lower consulting revenue. Services segment margin fell to 17% from 23%.
- Cloud and license segment margin was $4.873 billion, or 65% of segment revenue, versus $4.830 billion, or 66%, in the prior-year quarter. Hardware segment margin increased to 50% from 43% because expenses declined faster than revenue.
- Share repurchases increased substantially to $9.967 billion from $502 million. Oracle repurchased 212.2 million shares at an average price of $47.13 per share. Weighted-average diluted shares declined to 3.999 billion from 4.284 billion, contributing to EPS growth.
- Cash, cash equivalents and marketable securities declined 11% from May 31, 2018, primarily due to repurchases, debt repayment, dividends and capital expenditures.
- The Tax Act and related provisional accounting reduced the effective tax rate. Oracle recorded a $153 million benefit related to adjustments to its estimated transition tax under SAB 118.
- Amortization of intangible assets increased to $434 million from $411 million, primarily because of recent acquisitions.
- Revenue recognition changes under Topic 606 reduced the recast prior-year total revenue by $83 million and recast prior-year net income by $66 million compared with amounts previously reported; management characterized the overall impact as not material relative to historical amounts.
Guidance, Outlook, Commentary, Risks and Unusual Items
- Oracle expects total cloud and license revenue generally to increase on a constant-currency basis, supported by cloud services and license support growth, continued demand for cloud and on-premise licenses, and acquisitions. The filing does not provide specific quarterly or annual revenue or EPS guidance.
- Management expects continued strategic emphasis on cloud offerings and continued investment in research and development. It expects substantially all license support contracts to renew annually and anticipates renewal of eligible cloud contracts, although renewals are not guaranteed.
- Remaining performance obligations were $31.3 billion at August 31, 2018; approximately 64% was expected to be recognized as revenue over the next 12 months. Contract liabilities, including deferred revenue, totaled $11.019 billion.
- Oracle initiated a Fiscal 2019 Restructuring Plan with estimated costs of up to $432 million. It recorded $107 million in the quarter and expected to incur approximately $325 million of remaining costs, primarily through the end of fiscal 2020. Estimates may change.
- Seasonality is significant: revenue and operating margins are typically lowest in the first fiscal quarter and highest in the fourth fiscal quarter. Quarterly hardware revenue is described as difficult to predict.
- Oracle believes existing cash, marketable securities and operating cash flow will fund working capital, capital expenditures and contractual obligations, and believes it can fund acquisitions, dividends, repurchases and debt activity through internal resources, additional borrowings or securities issuance.
- Oracle faces a $3.0 billion jury award in litigation brought by Hewlett-Packard Enterprise, plus post-judgment interest. The award has not been recorded, Oracle is appealing, and the company cannot estimate a reasonably possible loss range. Oracle states that resolution could materially affect future cash flows and results of operations.
- Tax authorities are examining Oracle and acquired entities in multiple jurisdictions, including Australia, Brazil, India, Korea, Spain and the United Kingdom. Oracle believes its tax reserves are adequate, but states that outcomes and financial effects remain uncertain.
- Oracle is defending derivative litigation concerning its acquisition of NetSuite. The case was stayed for six months while a Special Litigation Committee investigates; Oracle does not currently expect a material impact.
- Oracle expects adoption of the future lease standard to increase reported assets and liabilities because most operating leases are expected to be recognized on the balance sheet.
Investor Verification Checklist
- Verify the sustainability of cloud services and license support growth, renewal rates, remaining performance obligations and the expected conversion of deferred revenue.
- Assess whether hardware and services declines reflect continued structural migration to cloud offerings or temporary demand and execution issues.
- Track the $432 million restructuring program, actual cash payments, remaining charges and whether expected operating efficiencies materialize.
- Review leverage, interest expense, debt maturities and the effect of continued share repurchases on liquidity and per-share results.
- Reconcile the 10.8% effective tax rate with provisional Tax Act accounting, the unresolved GILTI policy election and ongoing tax audits.
- Monitor the HP litigation appeal and potential exposure to the $3.0 billion judgment and related interest.
- Distinguish GAAP results from management segment measures, which include revenue adjustments and exclude items such as amortization, restructuring, stock compensation and certain allocations.