ORACLE CORP quarterly report, Q1 FY2020

Oracle Corporation Form 10-Q Summary

Business context and reporting period

Oracle provides cloud and on-premise applications and infrastructure technologies, hardware, and related services globally. Its three operating segments are cloud and license, hardware, and services. This unaudited Form 10-Q covers the three months ended August 31, 2019, the first quarter of fiscal 2020, with comparison to August 31, 2018. Oracle reported 3.288 billion common shares outstanding as of September 10, 2019.

Financial performance and position

Metric	Q1 FY2020	Q1 FY2019	Change
Total revenue	$9.218 billion	$9.193 billion	Flat reported; up 2% constant currency
Operating income	$2.877 billion	$2.778 billion	Up 4%
Operating margin	31%	30%	Up approximately 1 percentage point
Net income	$2.137 billion	$2.265 billion	Down 6%
Diluted EPS	$0.63	$0.57	Up 11%
Net cash from operations	$6.000 billion	$6.722 billion	Down 11%

Reported revenue was approximately flat because 2% constant-currency growth was offset by foreign exchange effects. Cloud services and license support revenue increased 3% to $6.805 billion, while cloud and on-premise license revenue declined 6% to $812 million. Hardware revenue declined 10% to $815 million, and services revenue declined 3% to $786 million.

Cloud and license represented approximately 83% of revenue and produced a 65% segment margin, compared with 65% in the prior-year quarter. Hardware produced a 53% segment margin, up from 50%, while services produced a 16% margin, down from 17%. Segment margins exclude certain corporate, acquisition, restructuring, stock-based compensation, amortization, interest, and other items and are not GAAP operating margins.

Interest expense declined to $494 million from $529 million, primarily due to lower average borrowings. Non-operating income declined to $99 million from $291 million, principally because interest income fell to $190 million from $348 million and foreign currency losses increased. The effective tax rate increased to 13.9% from 10.8%, partly because the prior-year period benefited from a $153 million Tax Cuts and Jobs Act-related adjustment.

At August 31, 2019, cash and cash equivalents were $31.083 billion and marketable securities were $4.621 billion, for total cash, cash equivalents, and marketable securities of $35.704 billion. Working capital was $23.509 billion. Current and non-current notes payable and other borrowings totaled $54.440 billion, excluding other liabilities. Senior notes outstanding totaled approximately $54.3 billion at fair value-related disclosure. Oracle repaid $1.750 billion of borrowings during the quarter.

Operating cash flow was $6.000 billion, capital expenditures were $386 million, and investing activities generated $12.386 billion, primarily because of marketable-securities sales and maturities. Financing activities used $7.802 billion, including $5.005 billion for share repurchases, $795 million for dividends, and $1.750 billion for debt repayment. Trailing-four-quarter free cash flow was $12.166 billion.

Material changes versus the prior comparable period

Cloud and license revenue increased 2% reported and 3% in constant currency, driven by cloud services, license support renewals, and customer demand for cloud deployment models.
Hardware revenue decreased 10% reported and 9% in constant currency as Oracle emphasized cloud-based infrastructure, reducing sales volumes for certain hardware product lines and related support.
Services revenue decreased 3% reported and 2% in constant currency, primarily due to lower consulting and education revenue.
Operating expenses declined 1% reported and were flat in constant currency; operating margin improved to 31%.
Net income declined despite higher operating income, primarily because of lower non-operating income and a higher effective tax rate.
Diluted EPS increased as weighted-average diluted shares declined to 3.410 billion from 3.999 billion, reflecting substantial share repurchases.
Share repurchases declined to $5.0 billion from $10.0 billion in the prior-year quarter. On September 11, 2019, the board authorized an additional $15.0 billion of repurchase capacity; approximately $848 million remained available as of August 31, 2019 before that expansion.
Oracle adopted the new lease standard, Topic 842, on June 1, 2019. The adoption had no material impact on quarterly operating results or cash flows but resulted in recognition of $2.0 billion of operating lease right-of-use assets and $2.061 billion of operating lease liabilities at August 31, 2019.

Guidance, outlook, commentary, risks, and unusual items

Management expects total cloud and license revenue generally to increase on a constant-currency basis, supported by cloud services, license support, and continued demand for cloud and on-premise licenses.
Oracle expects continued significant research and development investment and believes cloud services and infrastructure offerings are important growth opportunities.
Management expects substantially all license-support customers to renew annually, but renewals remain subject to customer decisions, competition, economic conditions, pricing, and foreign exchange.
The 2019 Restructuring Plan has estimated total costs of up to $584 million. Approximately $31 million remained to be incurred as of August 31, 2019, with most expected through the end of fiscal 2020. Expected savings are anticipated to be substantially offset by investments in cloud resources, infrastructure, sales, marketing, research, and development.
Restructuring expense was $78 million in the quarter. Acquisition-related and other expense was $25 million, including higher impairment costs related to certain abandoned right-of-use and other assets.
Remaining performance obligations were $33.8 billion, approximately 61% of which Oracle expected to recognize as revenue over the following twelve months.
Oracle is appealing a $3.0 billion jury award in litigation brought by Hewlett-Packard Enterprise. Oracle has posted a required surety bond, has not recorded or paid the award, and cannot estimate a reasonably possible loss range. The matter could materially affect future cash flows and results of operations.
Oracle faces tax audits and litigation in multiple jurisdictions involving significant amounts under controversy. Management believes adequate provisions have been recorded, but unfavorable outcomes could increase tax expense or liabilities.
Other securities, derivative, fiduciary-duty, and cloud-business litigation was disclosed. Management generally does not expect these matters to have a material impact, although outcomes remain uncertain.
Quarterly hardware revenue is difficult to predict. International operations, foreign exchange, cloud competition, customer renewals, government budgets, acquisitions, cybersecurity and technology execution are significant ongoing risks.

Important facts for investors to verify

Reconcile the flat reported revenue growth with the 2% constant-currency increase and assess the sustainability of cloud and license growth.
Monitor the transition from hardware and on-premise licenses toward cloud offerings, including its impact on revenue mix, margins, capital spending, and customer retention.
Review the sustainability of EPS growth, given that it was supported by a substantial reduction in diluted shares despite lower net income.
Assess leverage and refinancing needs against $35.7 billion of cash, cash equivalents, and marketable securities and approximately $54.4 billion of reported borrowings.
Track operating cash flow, deferred revenue, remaining performance obligations, and the timing of customer collections and renewals.
Verify the remaining restructuring costs, expected offsetting investments, and any additional asset impairments.
Follow the Hewlett-Packard litigation appeal and related potential cash-flow exposure.
Review tax examinations and litigation, including the effect of future changes in tax estimates and the pending adoption of the expected-credit-loss standard in fiscal 2021.