Oracle Corporation: Fiscal 2015 Second-Quarter Form 10-Q
Business context and reporting period
Oracle provides enterprise software, cloud infrastructure, hardware systems and related services. This unaudited Form 10-Q covers the three and six months ended November 30, 2014, representing the second quarter and first half of fiscal 2015. Fiscal 2015 runs from June 1, 2014 through May 31, 2015. Results include MICROS Systems from its September 8, 2014 acquisition date.
Key financial metrics
| Metric | Three months ended Nov. 30, 2014 | Three months ended Nov. 30, 2013 | Six months ended Nov. 30, 2014 | Six months ended Nov. 30, 2013 |
|---|---|---|---|---|
| Total revenues | $9,598 million | $9,275 million | $18,194 million | $17,647 million |
| Operating income | $3,542 million | $3,410 million | $6,506 million | $6,283 million |
| Operating margin | 36.9% | 36.8% | 35.8% | 35.6% |
| Net income | $2,502 million | $2,553 million | $4,685 million | $4,744 million |
| Diluted EPS | $0.56 | $0.56 | $1.04 | $1.02 |
| Net margin | 26.1% | 27.5% | 25.7% | 26.9% |
| Operating cash flow | Not separately provided | Not separately provided | $7,790 million | $7,438 million |
- Second-quarter revenue increased 3% as reported and 7% in constant currency. First-half revenue increased 3% as reported and 5% in constant currency.
- Software and cloud revenue was $7,329 million in the quarter and $13,905 million in the first half, up 5% and 5% as reported, respectively. Cloud SaaS/PaaS revenue increased 39% in the quarter and 36% in the first half; cloud IaaS revenue increased 60% and 42%, respectively.
- Software license updates and product support remained the largest and highest-margin business, generating $4,768 million in quarterly revenue and a reported segment margin of 89%.
- Hardware systems revenue increased 1% in the quarter but declined 3% in the first half. Services revenue declined 3% in the quarter and 5% in the first half.
- Cash, cash equivalents and marketable securities totaled $44,733 million at November 30, 2014, compared with $38,819 million at May 31, 2014. Working capital was $40,055 million.
- Six-month investing cash outflow was $12,909 million, including $5,122 million for acquisitions and $426 million of capital expenditures. Management-defined trailing-four-quarter free cash flow was $14,546 million.
- Total borrowings were $32,456 million at November 30, 2014, compared with $24,175 million at May 31, 2014. The company issued $10.0 billion of senior notes in July 2014 and repaid $1.5 billion of notes that matured.
Material changes versus the prior comparable period
- Revenue growth was led by software support, SaaS/PaaS and IaaS, while new software license revenue declined 4% in the quarter and 3% in the first half.
- Operating income increased 4% in both the quarter and first half, while net income declined 2% in both periods. Higher interest expense, a higher effective tax rate and lower non-operating income more than offset operating improvement.
- Interest expense increased to $282 million in the quarter and $544 million in the first half, compared with $230 million and $446 million, primarily because of higher average borrowings.
- The effective tax rate increased to 23.5% from 20.3% in the quarter and to 21.7% from 19.1% in the first half.
- Research and development expense increased 9% in the quarter and 8% in the first half, primarily due to increased headcount. Total stock-based compensation increased to $241 million in the quarter and $455 million in the first half.
- Oracle repurchased 101.6 million shares for $4.1 billion during the first half, compared with 176.1 million shares for $5.8 billion in the prior-year period. Approximately $13.2 billion remained available under the repurchase authorization at November 30, 2014.
- Foreign currency translation produced a $304 million decrease in comprehensive income for the first half, compared with a $127 million decrease in the prior-year period.
Guidance, outlook, management commentary, risks and unusual items
- Management expects software and cloud revenue generally to continue increasing on a constant-currency basis, supported by customer support renewals, cloud growth, acquisitions and continued research and development investment.
- Management expects software support revenue and margins to grow over the longer term, while hardware margins are expected to remain lower than software and cloud margins.
- Oracle expects to continue acquisitions and believes available cash, marketable securities, operating cash flow, additional borrowings and potential securities issuances can fund acquisitions, dividends, repurchases and debt obligations.
- The MICROS acquisition had preliminary purchase accounting, including $3.3 billion of goodwill and $2.0 billion of intangible assets. Valuations and certain liabilities remained subject to measurement-period adjustments.
- Oracle initiated a Fiscal 2015 Restructuring Plan with estimated costs of up to $626 million. It recorded $13 million during the first half and expected to incur approximately $613 million of remaining costs, primarily through fiscal 2016.
- The second quarter included a $53 million operating benefit from the conclusion of SAP litigation. Oracle received approximately $359.2 million, including $306 million applied against a previously recorded receivable.
- Deferred revenue totaled $7,224 million at November 30, 2014, down from $7,673 million at May 31, 2014. Revenue recognition for acquired support and cloud contracts was reduced by acquisition-date fair-value adjustments, with full contract values generally expected to be recognized upon renewal.
- Key risks include foreign currency volatility, dependence on international operations, timing and size of large software and hardware transactions, acquisition integration and valuation, restructuring execution, tax audits, litigation, customer renewals, competition and interest-rate exposure.
- A 100-basis-point increase in LIBOR was estimated to increase annual interest expense by approximately $73 million. The company reported compliance with debt covenants and no material off-balance-sheet arrangements.
- Oracle accepted a $356.7 million remittitur in the SAP matter; the action was concluded. The HP litigation remained pending, and Oracle stated that it could not estimate a reasonably possible loss range.
Important facts for investors to verify
- Reconcile reported growth with constant-currency growth and assess the effect of the stronger U.S. dollar on future revenue, expenses and comprehensive income.
- Evaluate whether cloud SaaS, PaaS and IaaS growth can offset slower new software license trends and declining first-half services revenue.
- Assess the sustainability of margins after excluding the $53 million SAP litigation benefit, acquisition accounting effects, amortization, stock compensation and restructuring charges.
- Monitor leverage, interest expense and refinancing exposure following the $10.0 billion senior-notes issuance and the use of debt to support acquisitions, repurchases and dividends.
- Track MICROS integration, preliminary goodwill and intangible-asset valuations, related amortization and the potential for future impairment or restructuring costs.
- Verify the timing and ultimate cost of the Fiscal 2015 Restructuring Plan, including the estimated $613 million of remaining costs.
- Review tax-audit developments, the realizability of approximately $908 million of net deferred tax assets and the effect of future changes in tax jurisdictional mix.
- Confirm customer renewal rates for software support, cloud contracts and hardware support, which underpin recurring revenue and deferred-revenue conversion.