Oracle Corporation: Fiscal 2017 Second-Quarter 10-Q Summary
Business Context and Reporting Period
Oracle provides cloud SaaS, PaaS and IaaS offerings, on-premise software, hardware and related services to more than 400,000 customers worldwide. This unaudited Form 10-Q covers the three and six months ended November 30, 2016, the second quarter and first half of fiscal 2017.
Oracle completed its acquisition of NetSuite on November 7, 2016. NetSuite was a related-party transaction because Lawrence J. Ellison was affiliated with NetSuite’s largest stockholder. Oracle recorded a preliminary purchase price of approximately $9.1 billion, including approximately $9.0 billion in cash.
Key Financial Metrics
| Metric | Three Months Ended November 30, 2016 | Three Months Ended November 30, 2015 | Six Months Ended November 30, 2016 | Six Months Ended November 30, 2015 |
|---|---|---|---|---|
| Revenue | $9.035 billion | $8.993 billion | $17.630 billion | $17.441 billion |
| Operating income | $3.037 billion | $2.955 billion | $5.678 billion | $5.609 billion |
| Operating margin | 33.6% | 32.9% | 32.2% | 32.2% |
| Net income | $2.032 billion | $2.197 billion | $3.864 billion | $3.945 billion |
| Diluted EPS | $0.48 | $0.51 | $0.92 | $0.90 |
| Operating cash flow | Not separately reported | Not separately reported | $6.961 billion | $6.397 billion |
- Revenue mix: Second-quarter cloud revenue was $1.053 billion, up from $649 million. SaaS and PaaS revenue was $878 million, up 81%, while IaaS revenue was $175 million, up 6%.
- Software transition: New software licenses declined 20% to $1.347 billion, while software license updates and product support increased 2% to $4.777 billion.
- Other businesses: Hardware revenue declined 10% to $1.014 billion; services revenue declined 2% to $844 million.
- Cash generation: First-half operating cash flow increased 9% year over year. Trailing-four-quarter free cash flow was $12.645 billion, calculated as operating cash flow of $14.249 billion less capital expenditures of $1.604 billion.
- Liquidity: Cash, cash equivalents and marketable securities totaled $58.206 billion at November 30, 2016, including $51.1 billion held by foreign subsidiaries. Working capital was $48.387 billion.
- Debt: Current and non-current notes payable and other borrowings totaled approximately $54.327 billion. Oracle issued $14.0 billion of senior notes in July 2016. Management stated that all debt covenants were satisfied.
- Capital returns: Oracle repurchased 62.0 million shares for $2.5 billion during the first half and paid $1.232 billion of dividends. Approximately $6.3 billion remained available under the repurchase authorization.
Material Changes Versus the Prior Comparable Period
- Total revenue increased 0.5% in the quarter and 1.1% in the first half on a reported basis; constant-currency growth was 1% and 2%, respectively.
- Cloud and on-premise software revenue increased 2% in the quarter and 4% in the first half on a reported basis. Constant-currency growth was 3% and 5%.
- Cloud SaaS and PaaS revenue growth was partly offset by lower new software license revenue, reflecting Oracle’s strategic shift toward cloud offerings.
- Reported net income declined 8% in the quarter and 2% in the first half. The effective tax rate increased to 24.3% from 17.6% in the quarter and to 23.6% from 20.8% in the first half, primarily due to prior-year tax settlements and jurisdictional mix.
- Interest expense increased 22% in the quarter and 16% in the first half because of higher average borrowings following the July 2016 debt issuance.
- First-half investing cash use increased to $14.920 billion from $3.338 billion, primarily because of the NetSuite acquisition, other acquisitions, marketable securities purchases and higher capital expenditures.
- Goodwill increased from $34.590 billion at May 31, 2016 to $42.083 billion at November 30, 2016, primarily reflecting acquisitions, including $6.696 billion of preliminary NetSuite goodwill.
Guidance, Outlook, Risks and Unusual Items
- Management expects cloud and on-premise software revenue to generally increase on a constant-currency basis, driven by cloud growth, support renewals, on-premise demand and acquisitions. No quantitative revenue or earnings guidance is provided in the filing.
- Oracle expects continued strategic investment in SaaS, PaaS and IaaS, research and development and acquisitions. These investments may pressure cloud margins and new software license revenue in the near term.
- The Fiscal 2017 Restructuring Plan has estimated costs of up to $502 million. Oracle recorded $202 million through the first half and expected to incur approximately $300 million more, primarily through fiscal 2018.
- Oracle faces a $3.0 billion jury award in litigation brought by Hewlett-Packard Enterprise. No amount was recorded, Oracle filed a motion for a new trial and intends to appeal if necessary. The filing states that the matter could materially affect future cash flows and results of operations, but a reasonably possible loss range cannot currently be estimated.
- NetSuite purchase accounting remains preliminary, including the valuation of intangible assets, certain liabilities, taxes and goodwill. The acquisition included assumed convertible notes with a fair value of $342 million.
- Oracle’s international operations create exposure to foreign currency movements, and a significant portion of overseas cash would be subject to U.S. tax if repatriated.
- Tax authorities are examining Oracle and acquired entities in the United States and other jurisdictions, including India, Brazil and Korea. The company believes existing provisions are adequate but cannot assure the ultimate outcomes.
- Oracle adopted ASU 2016-09 for stock-based compensation, which increased the first-half operating cash flow comparison by $40 million on a retrospective basis and changed the treatment of excess tax benefits.
- Oracle preliminarily planned to adopt the new revenue recognition standard in fiscal 2019 and stated that it did not expect a material revenue impact, although its assessment remained subject to change.
Most Important Facts for Investors to Verify
- Whether rapid SaaS and PaaS growth can offset continuing declines in new software licenses and weaker hardware and services revenue.
- The final purchase accounting, revenue contribution, retention and integration costs associated with the $9.1 billion NetSuite acquisition.
- The effect of approximately $54.3 billion of borrowings on interest expense, leverage, liquidity and future capital allocation.
- The timing and ultimate cost of the Fiscal 2017 Restructuring Plan, including the remaining estimated $300 million.
- The potential cash and earnings impact of the unresolved $3.0 billion HP litigation award and related appeal.
- The sustainability of reported margins after considering higher cloud infrastructure and personnel investment, stock-based compensation, acquisition amortization and tax-rate changes.
- The geographic availability and potential tax cost of Oracle’s $58.2 billion of cash and marketable securities, particularly the $51.1 billion held overseas.