Oracle Corporation: Fiscal 2011 Third-Quarter Form 10-Q Summary
Business context and reporting period
Oracle filed an unaudited Form 10-Q for the three and nine months ended February 28, 2011, covering fiscal 2011, which runs from June 1, 2010 through May 31, 2011. Oracle operates software, hardware systems, and services businesses. Comparability with fiscal 2010 is significantly affected by the January 2010 acquisition of Sun Microsystems, which added the hardware systems business and materially increased reported revenue, expenses, goodwill, intangible assets, and debt-related costs.
Key financial metrics
| Metric | Three months ended February 28, 2011 | Three months ended February 28, 2010 | Nine months ended February 28, 2011 | Nine months ended February 28, 2010 |
|---|---|---|---|---|
| Total revenue | $8.764 billion | $6.404 billion | $24.847 billion | $17.315 billion |
| Operating income | $2.987 billion | $1.843 billion | $7.674 billion | $5.762 billion |
| Operating margin | 34.1% | 28.8% | 30.9% | 33.3% |
| Net income | $2.116 billion | $1.189 billion | $5.338 billion | $3.772 billion |
| Net margin | 24.1% | 18.6% | 21.5% | 21.8% |
| Diluted EPS | $0.41 | $0.23 | $1.04 | $0.74 |
| Cash flow from operations | Not separately provided for the quarter | Not separately provided for the quarter | $7.437 billion | $6.170 billion |
- Quarterly revenue increased 37% reported and 35% in constant currency; nine-month revenue increased 44% both reported and in constant currency.
- Quarterly net income increased 78%; nine-month net income increased 42%.
- Software revenue was $5.954 billion in the quarter and $16.333 billion for nine months. Hardware systems revenue was $1.664 billion and $5.115 billion, respectively. Services revenue was $1.146 billion and $3.399 billion, respectively.
- Software license updates and product support remained the highest-margin business, with an 86% reported segment margin for both the quarter and nine-month period.
- Hardware systems products generated a 19% segment margin in the quarter and an 19% margin for nine months, compared with a negative 25% margin in the comparable fiscal 2010 periods.
- Research and development expense increased to $1.127 billion for the quarter and $3.349 billion for nine months, including the full-period impact of Sun-related headcount and infrastructure.
- Amortization of acquired intangible assets was $612 million for the quarter and $1.829 billion for nine months. Estimated future amortization was $8.274 billion for amortizable intangible assets as of February 28, 2011.
Cash flow, liquidity, debt, and capital allocation
- Cash and cash equivalents were $11.864 billion at February 28, 2011, compared with $9.914 billion at May 31, 2010. Marketable securities were $12.491 billion, producing total cash, cash equivalents, and marketable securities of $24.355 billion.
- Working capital was $21.177 billion, compared with $12.313 billion at May 31, 2010. Approximately $21.9 billion of cash, cash equivalents, and marketable securities was held by foreign subsidiaries.
- Operating cash flow increased 21% to $7.437 billion for the first nine months. Investing cash flow used $5.662 billion, including $1.673 billion for acquisitions and $372 million of capital expenditures. Financing cash flow used $343 million.
- Trailing-four-quarter free cash flow was $9.507 billion, up 19% from $7.979 billion, based on Oracle’s non-GAAP calculation.
- Total borrowings were approximately $14.75 billion, all classified as non-current at February 28, 2011. Oracle had no commercial paper outstanding and no borrowings under its revolving credit agreement.
- Oracle issued $3.25 billion of fixed-rate senior notes in July 2010 and repaid $2.25 billion of senior notes at maturity in January 2011. The $3.0 billion revolving credit agreement expired on March 14, 2011, with no debt outstanding under it.
- Debt principal payments total $14.75 billion, with $1.25 billion due in fiscal 2013, $1.5 billion in fiscal 2015, $2.0 billion in fiscal 2016, and $10.0 billion thereafter.
- Oracle repurchased 28.0 million shares for approximately $750 million during the first nine months and had approximately $4.5 billion remaining under its authorization at February 28, 2011. The quarterly dividend was increased from $0.05 to $0.06 per share in March 2011.
Material changes versus the prior comparable period
- The Sun acquisition drove most of the year-over-year expansion in hardware revenue and added a full comparable fiscal 2011 quarter of Sun revenue and expenses. Sun contributed $5.1 billion of hardware systems revenue and $705 million of software revenue during the first nine months.
- Quarterly hardware systems revenue increased from $458 million to $1.664 billion. Nine-month hardware systems revenue increased from $458 million to $5.115 billion because fiscal 2010 included only a partial post-acquisition period.
- Quarterly operating margin improved from 29% to 34%, while the nine-month operating margin declined from 33% to 31%. Management attributed the nine-month margin pressure primarily to Sun-related expenses, including research and development, acquisition-related costs, and amortization, partially offset by lower restructuring expense and a $120 million recovery of legal costs.
- Interest expense increased 10% for the quarter and 11% for nine months because of higher average borrowings following the July 2010 senior-note issuance.
- Non-operating income improved to $16 million for the quarter and $180 million for nine months, compared with non-operating expense of $75 million and $41 million, respectively. The prior-year periods included significant Venezuelan currency remeasurement losses.
- Sun restructuring expense was $96 million for the quarter and $366 million for nine months. Total estimated Sun restructuring costs were approximately $1.1 billion, with approximately $389 million remaining as of February 28, 2011.
Outlook, commentary, risks, contingencies, and unusual items
- Management expected software revenue to continue increasing in constant currency, supported by demand, acquisitions, and high software-support renewal rates. Support revenue represented approximately 42% of trailing-four-quarter revenue and carried an approximately 86% trailing-four-quarter margin.
- Management expected the hardware systems business to remain a significant source of revenue and expense, but to have lower margins than the software business. Results remain sensitive to the timing of large customer orders, manufacturing and delivery execution, product mix, and support renewals.
- Oracle highlighted risks from economic and political conditions, foreign exchange, intense competition, product delays, large-transaction timing, support-renewal rates, acquisitions and integration, and the ongoing expansion into hardware.
- Oracle was monitoring potential effects of the March 2011 earthquake and tsunami in Japan on sales, supply chains, and operations.
- Oracle reported a $1.3 billion jury award against SAP. The judgment, entered February 3, 2011, had not been received and was not recorded as income; SAP filed post-trial motions.
- Oracle continued to defend intellectual-property litigation involving Parallel Networks and government-related litigation concerning alleged General Services Administration pricing and discount issues. Management stated that it believed it had meritorious defenses and that the disclosed litigation was not expected to have a material adverse effect, although outcomes remain uncertain.
- Unrecognized tax benefits, including related interest and penalties, totaled approximately $3.1 billion. Approximately $120 million was subject to settlement agreements, with the timing of payment uncertain.
- Recent acquisitions included Phase Forward for approximately $736 million and Art Technology Group for approximately $1.0 billion. Their individual financial results were not material to the consolidated statements.
- Management stated that current liquidity, operating cash flow, and available financing resources were expected to satisfy working capital, capital expenditure, and contractual obligations, as well as support potential acquisitions, dividends, and share repurchases.
Important facts for investors to verify
- Assess the underlying organic growth and profitability of Oracle excluding the substantial acquisition and integration effects from Sun, Phase Forward, and ATG.
- Track whether hardware systems margins remain positive and whether hardware growth produces acceptable returns after research and development, restructuring, amortization, and support costs.
- Reconcile reported operating margin with the significant recurring and acquisition-related charges, including $8.274 billion of remaining amortizable intangible assets and approximately $389 million of remaining Sun restructuring costs.
- Monitor debt maturities, interest expense, and the absence of a committed revolving credit facility after the March 14, 2011 expiration of the prior facility.
- Verify the ultimate outcome and collectability of the $1.3 billion SAP judgment and any potential exposure from the GSA-related litigation and tax examinations.
- Evaluate the sustainability of cash generation after acquisitions, dividends, share repurchases, restructuring payments, and debt repayments.
- Review the effects of foreign exchange movements, Japan-related operational disruptions, and software and hardware support-renewal rates on future results.