UNITED STATES
FORM 10-Q
|
x QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
||
| For the Quarterly Period Ended November 30, 2004 | ||
| OR | ||
|
o TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
||
| For the transition period from to . | ||
Commission file number: 0-14376
Oracle Corporation
|
Delaware
|
94-2871189 | |
|
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification no.) |
500 Oracle Parkway
(650) 506-7000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES x NO o
The number of shares of registrant’s common stock outstanding as of December 15, 2004: 5,224,865,586
ORACLE CORPORATION
FORM 10-Q QUARTERLY REPORT
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
| Item 1. | Financial Statements |
ORACLE CORPORATION
| November 30, | May 31, | |||||||||
| (in millions, except per share data) | 2004 | 2004 | ||||||||
|
ASSETS
|
||||||||||
|
Current assets:
|
||||||||||
|
Cash and cash equivalents
|
$ | 5,905 | $ | 4,138 | ||||||
|
Short-term investments
|
3,531 | 4,449 | ||||||||
|
Trade receivables, net of allowances of $313 as
of November 30, 2004 and $364 as of May 31, 2004
|
1,532 | 2,012 | ||||||||
|
Other receivables
|
212 | 322 | ||||||||
|
Deferred tax assets
|
298 | 301 | ||||||||
|
Prepaid expenses and other current assets
|
95 | 114 | ||||||||
|
Total current assets
|
11,573 | 11,336 | ||||||||
|
Non-current assets:
|
||||||||||
|
Property, net
|
1,084 | 1,068 | ||||||||
|
Deferred tax assets
|
81 | 92 | ||||||||
|
Other assets
|
399 | 267 | ||||||||
|
Total non-current assets
|
1,564 | 1,427 | ||||||||
|
Total assets
|
$ | 13,137 | $ | 12,763 | ||||||
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
||||||||||
|
Current liabilities:
|
||||||||||
|
Accounts payable
|
$ | 260 | $ | 191 | ||||||
|
Current portion of long-term debt
|
9 | 9 | ||||||||
|
Income taxes payable
|
904 | 950 | ||||||||
|
Accrued compensation and related benefits
|
505 | 556 | ||||||||
|
Other accrued liabilities
|
809 | 1,069 | ||||||||
|
Deferred revenues
|
1,497 | 1,497 | ||||||||
|
Total current liabilities
|
3,984 | 4,272 | ||||||||
|
Non-current liabilities:
|
||||||||||
|
Notes payable and long-term debt, net of current
portion
|
162 | 163 | ||||||||
|
Deferred tax liabilities
|
17 | 59 | ||||||||
|
Other long-term liabilities
|
375 | 274 | ||||||||
|
Total non-current liabilities
|
554 | 496 | ||||||||
|
Commitments and contingencies
|
||||||||||
|
Stockholders’ equity:
|
||||||||||
|
Preferred stock, $0.01 par value—
authorized: 1.0 shares; outstanding: none
|
— | — | ||||||||
|
Common stock, $0.01 par value and additional
paid in capital—authorized: 11,000 shares;
outstanding: 5,104 shares at November 30, 2004 and
5,171 shares at May 31, 2004
|
5,578 | 5,456 | ||||||||
|
Retained earnings
|
2,705 | 2,383 | ||||||||
|
Accumulated other comprehensive income
|
316 | 156 | ||||||||
|
Total stockholders’ equity
|
8,599 | 7,995 | ||||||||
|
Total liabilities and stockholders’ equity
|
$ | 13,137 | $ | 12,763 | ||||||
See notes to condensed consolidated financial statements.
1
ORACLE CORPORATION
| Three Months Ended | Six Months Ended | ||||||||||||||||||
| November 30, | November 30, | ||||||||||||||||||
| (in millions, except per share data) | 2004 | 2003 | 2004 | 2003 | |||||||||||||||
|
Revenues:
|
|||||||||||||||||||
|
New software licenses
|
$ | 971 | $ | 855 | $ | 1,534 | $ | 1,380 | |||||||||||
|
Software license updates and product support
|
1,252 | 1,114 | 2,427 | 2,148 | |||||||||||||||
|
Software revenues
|
2,223 | 1,969 | 3,961 | 3,528 | |||||||||||||||
|
Services
|
533 | 529 | 1,010 | 1,042 | |||||||||||||||
|
Total revenues
|
2,756 | 2,498 | 4,971 | 4,570 | |||||||||||||||
|
Operating expenses:
|
|||||||||||||||||||
|
Sales and marketing
|
555 | 525 | 1,035 | 989 | |||||||||||||||
|
Software license updates and product support
|
141 | 143 | 277 | 264 | |||||||||||||||
|
Cost of services
|
449 | 455 | 868 | 897 | |||||||||||||||
|
Research and development
|
327 | 323 | 639 | 621 | |||||||||||||||
|
General and administrative
|
153 | 137 | 307 | 268 | |||||||||||||||
|
Total operating expenses
|
1,625 | 1,583 | 3,126 | 3,039 | |||||||||||||||
|
Operating income
|
1,131 | 915 | 1,845 | 1,531 | |||||||||||||||
|
Other income, net
|
23 | 1 | 47 | 49 | |||||||||||||||
|
Income before provision for income taxes
|
1,154 | 916 | 1,892 | 1,580 | |||||||||||||||
|
Provision for income taxes
|
339 | 299 | 568 | 523 | |||||||||||||||
|
Net income
|
$ | 815 | $ | 617 | $ | 1,324 | $ | 1,057 | |||||||||||
|
Earnings per share:
|
|||||||||||||||||||
|
Basic
|
$ | 0.16 | $ | 0.12 | $ | 0.26 | $ | 0.20 | |||||||||||
|
Diluted
|
$ | 0.16 | $ | 0.12 | $ | 0.25 | $ | 0.20 | |||||||||||
|
Weighted average common shares outstanding:
|
|||||||||||||||||||
|
Basic
|
5,123 | 5,226 | 5,139 | 5,228 | |||||||||||||||
|
Diluted
|
5,218 | 5,337 | 5,229 | 5,342 | |||||||||||||||
See notes to condensed consolidated financial statements.
2
ORACLE CORPORATION
| Six Months Ended | ||||||||||||
| November 30, | ||||||||||||
| (in millions) | 2004 | 2003 | ||||||||||
|
Cash Flows From Operating Activities:
|
||||||||||||
|
Net income
|
$ | 1,324 | $ | 1,057 | ||||||||
|
Adjustments to reconcile net income to net cash
provided by operating activities:
|
||||||||||||
|
Depreciation
|
89 | 100 | ||||||||||
|
Amortization of intangible assets
|
16 | 21 | ||||||||||
|
Net investment gains related to equity securities
|
(1 | ) | (32 | ) | ||||||||
|
Deferred income taxes
|
(28 | ) | 20 | |||||||||
|
Minority interests in income
|
19 | 23 | ||||||||||
|
Changes in assets and liabilities:
|
||||||||||||
|
Decrease in trade receivables
|
527 | 389 | ||||||||||
|
Decrease in prepaid expenses and other assets
|
153 | 80 | ||||||||||
|
Decrease in accounts payable and other liabilities
|
(275 | ) | (139 | ) | ||||||||
|
Increase in income taxes payable
|
24 | 135 | ||||||||||
|
Decrease in deferred revenues
|
(49 | ) | (46 | ) | ||||||||
|
Net cash provided by operating activities
|
1,799 | 1,608 | ||||||||||
|
Cash Flows From Investing Activities:
|
||||||||||||
|
Purchases of investments
|
(5,097 | ) | (5,252 | ) | ||||||||
|
Proceeds from maturities and sale of investments
|
6,011 | 3,397 | ||||||||||
|
Capital expenditures
|
(92 | ) | (103 | ) | ||||||||
|
Increase in other assets
|
(4 | ) | (8 | ) | ||||||||
|
Net cash provided by (used for) investing
activities
|
818 | (1,966 | ) | |||||||||
|
Cash Flows From Financing Activities:
|
||||||||||||
|
Payments for repurchase of common stock
|
(1,095 | ) | (399 | ) | ||||||||
|
Proceeds from issuance of common stock
|
165 | 176 | ||||||||||
|
Distributions to minority interests
|
(26 | ) | (21 | ) | ||||||||
|
Net cash used for financing activities
|
(956 | ) | (244 | ) | ||||||||
|
Effect of exchange rate changes on cash and cash
equivalents
|
106 | 38 | ||||||||||
|
Net increase (decrease) in cash and cash
equivalents
|
1,767 | (564 | ) | |||||||||
|
Cash and cash equivalents at beginning of period
|
4,138 | 4,737 | ||||||||||
|
Cash and cash equivalents at end of period
|
$ | 5,905 | $ | 4,173 | ||||||||
See notes to condensed consolidated financial statements.
3
ORACLE CORPORATION
| 1. | BASIS OF PRESENTATION |
We have prepared the condensed consolidated financial statements included herein, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, we believe that the disclosures are adequate to ensure the information presented is not misleading. These unaudited condensed consolidated financial statements should be read in conjunction with the audited financial statements and the notes thereto included in our Annual Report on Form 10-K for the fiscal year ended May 31, 2004.
We believe that all necessary adjustments, which consisted only of normal recurring items, have been included in the accompanying financial statements to present fairly the results of the interim periods. The results of operations for the interim periods presented are not necessarily indicative of the operating results to be expected for any subsequent interim period or for our fiscal year ending May 31, 2005. Certain prior period balances have been reclassified to conform to the current period presentation.
| 2. | STOCK BASED COMPENSATION PLANS |
We issue stock options to our employees and outside directors and provide employees the right to purchase our stock pursuant to stockholder approved stock option and employee stock purchase programs. We account for our stock-based compensation plans under the intrinsic value method of accounting as defined by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. We apply the disclosure provisions of Financial Accounting Standards Board Statement No. 123, Accounting for Stock-Based Compensation, as amended by Statement 148, Accounting for Stock-Based Compensation— Transition and Disclosure. For pro forma disclosures, the estimated fair value of the options is amortized using the accelerated expense attribution method over the vesting period, typically four years, and the estimated fair value of the stock purchases is amortized over the six-month purchase period. The following table illustrates the effect on net income and earnings per share if we had accounted for our stock option and stock purchase plans under the fair value method of accounting:
| Three Months Ended | Six Months Ended | ||||||||||||||||
| November 30, | November 30, | ||||||||||||||||
| (in millions, except per share data) | 2004 | 2003 | 2004 | 2003 | |||||||||||||
|
Net income, as reported
|
$ | 815 | $ | 617 | $ | 1,324 | $ | 1,057 | |||||||||
|
Deduct: Stock-based employee
compensation expense determined under the fair value based
method for awards, net of related tax effects
|
(41 | ) | (57 | ) | (79 | ) | (83 | ) | |||||||||
|
Pro forma net income
|
$ | 774 | $ | 560 | $ | 1,245 | $ | 974 | |||||||||
|
Earnings per share:
|
|||||||||||||||||
|
Basic—as reported
|
$ | 0.16 | $ | 0.12 | $ | 0.26 | $ | 0.20 | |||||||||
|
Basic—pro forma
|
$ | 0.15 | $ | 0.11 | $ | 0.24 | $ | 0.19 | |||||||||
|
Diluted—as reported
|
$ | 0.16 | $ | 0.12 | $ | 0.25 | $ | 0.20 | |||||||||
|
Diluted—pro forma
|
$ | 0.15 | $ | 0.10 | $ | 0.24 | $ | 0.18 | |||||||||
4
We estimate the fair value of our options using a Black-Scholes option-pricing model, which was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. Option valuation models require the input of assumptions, including the expected stock price volatility. Our options have characteristics significantly different from those of traded options, and changes in the input assumptions can materially affect the fair value estimates. The fair value of options granted and the option component of the employee purchase plan shares were estimated at the date of grant using a Black-Scholes pricing model with the following weighted average assumptions:
| Three Months Ended | Six Months Ended | |||||||||||||||
| November 30, | November 30, | |||||||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||||||
|
Employee and Director Stock Options
|
||||||||||||||||
|
Expected life from vest date (in years)
|
1.31 | 1.35 | 1.28-2.54 | 1.26-3.00 | ||||||||||||
|
Risk-free interest rate
|
3.00-3.69% | 2.03-3.35% | 2.40-3.69% | 2.03-4.09% | ||||||||||||
|
Volatility
|
34% | 40% | 34-36% | 40-44% | ||||||||||||
|
Dividend yield
|
— | — | — | — | ||||||||||||
|
Weighted average fair value of grants
|
$ | 3.26 | $ | 4.19 | $ | 3.42 | $ | 4.79 | ||||||||
|
Employee Stock Purchase Plan
|
||||||||||||||||
|
Expected life (in years)
|
0.50 | 0.50 | 0.50 | 0.50 | ||||||||||||
|
Risk-free interest rate
|
1.69% | 1.10% | 1.69% | 1.10% | ||||||||||||
|
Volatility
|
37% | 48% | 37% | 48% | ||||||||||||
|
Dividend yield
|
— | — | — | — | ||||||||||||
|
Weighted average fair value of grants
|
$ | 3.09 | $ | 3.10 | $ | 3.09 | $ | 3.10 | ||||||||
5
| 3. | EARNINGS PER SHARE |
Basic earnings per share is computed by dividing net income for the period by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income for the period by the weighted average number of common shares outstanding during the period, plus the dilutive effect of outstanding stock options and shares issuable under the employee stock purchase plan using the treasury stock method. The following table sets forth the computation of basic and diluted earnings per share:
| Three Months Ended | Six Months Ended | |||||||||||||||
| November 30, | November 30, | |||||||||||||||
| (in millions, except per share data) | 2004 | 2003 | 2004 | 2003 | ||||||||||||
|
Net income
|
$ | 815 | $ | 617 | $ | 1,324 | $ | 1,057 | ||||||||
|
Weighted average common shares outstanding
|
5,123 | 5,226 | 5,139 | 5,228 | ||||||||||||
|
Dilutive effect of employee stock plans
|
95 | 111 | 90 | 114 | ||||||||||||
|
Diluted weighted average common shares outstanding
|
5,218 | 5,337 | 5,229 | 5,342 | ||||||||||||
|
Basic earnings per share
|
$ | 0.16 | $ | 0.12 | $ | 0.26 | $ | 0.20 | ||||||||
|
Diluted earnings per share
|
$ | 0.16 | $ | 0.12 | $ | 0.25 | $ | 0.20 | ||||||||
|
Shares subject to anti-dilutive options excluded
from calculation(1)
|
139 | 148 | 144 | 141 | ||||||||||||
|
|
| (1) | These weighted average shares relate to anti-dilutive stock options and could be dilutive in the future. |
| 4. | COMPREHENSIVE INCOME |
Comprehensive income includes foreign currency translation gains and losses, unrealized gains and losses on equity securities and equity hedge gains and losses that are reflected in stockholders’ equity instead of net income. The following table sets forth the calculation of comprehensive income:
| Three Months Ended | Six Months Ended | ||||||||||||||||
| November 30, | November 30, | ||||||||||||||||
| (in millions) | 2004 | 2003 | 2004 | 2003 | |||||||||||||
|
Net income
|
$ | 815 | $ | 617 | $ | 1,324 | $ | 1,057 | |||||||||
|
Net foreign currency translation gains
|
185 | 156 | 195 | 65 | |||||||||||||
|
Reversal of unrealized gain on equity securities,
net
|
— | — | — | (25 | ) | ||||||||||||
|
Unrealized gain (loss) on equity securities, net
|
— | 1 | (1 | ) | 1 | ||||||||||||
|
Equity hedge losses, net
|
(27 | ) | (28 | ) | (34 | ) | (30 | ) | |||||||||
|
Comprehensive income
|
$ | 973 | $ | 746 | $ | 1,484 | $ | 1,068 | |||||||||
6
| 5. | DEFERRED REVENUES |
The following table sets forth the components of deferred revenues:
| November 30, | May 31, | ||||||||
| (in millions) | 2004 | 2004 | |||||||
|
Software license updates and product support
|
$ | 1,337 | $ | 1,329 | |||||
|
Services
|
91 | 99 | |||||||
|
New software licenses
|
69 | 69 | |||||||
|
Total deferred revenues
|
$ | 1,497 | $ | 1,497 | |||||
Deferred software license updates and product support revenues represent customer payments made in advance for annual support contracts. Software license updates and product support are typically billed on a per annum basis in advance and revenue is recognized ratably over the support period. The deferred software license updates and product support revenues are typically highest at the end of our first fiscal quarter due to the collection of cash from the large volume of service contracts that are sold or renewed in May of each year. Deferred service revenues include prepayments for consulting, advanced product services and education services. Revenue for these services is recognized as the services are performed. Deferred new software license revenues typically result from undelivered products or specified enhancements, customer specific acceptance provisions or software license transactions that are not segmentable from consulting services.
| 6. | STOCK REPURCHASE PROGRAM |
Our Board of Directors has approved a program to repurchase shares of our common stock to reduce the dilutive effect of our stock option and stock purchase plans. From the inception of the stock repurchase program in 1992 to November 30, 2004, a total of 1,768.2 million shares have been repurchased for approximately $20.1 billion. We repurchased 93.9 million shares for $1,094.8 million and 33.3 million shares for $399.4 million during the six months ended November 30, 2004 and 2003, respectively. At November 30, 2004, approximately $2.2 billion was available to repurchase shares of our common stock pursuant to the stock repurchase program.
| 7. | SEGMENT REPORTING |
FASB Statement No. 131, Disclosures about Segments of an Enterprise and Related Information, establishes standards for reporting information about operating segments. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. Our chief operating decision maker is our Chief Executive Officer. We are organized geographically and by line of business. While our Chief Executive Officer evaluates results in a number of different ways, the line of business management structure is the primary basis for which the allocation of resources and financial results are assessed. We are organized into two businesses, which are further organized into five operating segments. Our software business is comprised of two operating segments: (1) new software licenses and (2) software license updates and product support. Our services business is comprised of three operating segments: (1) consulting, (2) advanced product services and (3) education.
The new software license line of business is engaged in the licensing of database technology software and applications software. Database technology software includes database management software, application server software, development tools and collaboration software. Applications software includes financials, projects, marketing, sales, order management, procurement, supply chain, manufacturing, services and human resources, which can be accessed with standard web browsers and can be used to automate business processes
7
and provide business intelligence. The software license updates and product support line of business provides customers with rights to unspecified software product upgrades and maintenance releases, internet access to technical content, as well as internet and telephone access to technical support personnel during the support period.
The consulting line of business assists customers in the design, implementation, deployment, upgrade and migration of our database technology and applications software. Advanced product services are comprised of Oracle On Demand and advanced product support services. Oracle On Demand provides multi-featured software and hardware management and maintenance services for our database technology and applications software. Advanced product support services are earned by providing customers configuration and performance analysis, personalized support and annual on-site technical services. The education line of business provides instructor led, media based and internet based training in the use of our database technology and applications software.
We do not track our assets by operating segments. Consequently, it is not practical to show assets by operating segment.
8
The following table presents a summary of our operating segments(1):
| Three Months Ended | Six Months Ended | ||||||||||||||||||
| November 30, | November 30, | ||||||||||||||||||
| (in millions) | 2004 | 2003 | 2004 | 2003 | |||||||||||||||
|
New software licenses:
|
|||||||||||||||||||
|
Revenues(2)
|
$ | 969 | $ | 852 | $ | 1,530 | $ | 1,376 | |||||||||||
|
Sales and distribution expenses
|
447 | 413 | 830 | 778 | |||||||||||||||
|
Margin(3)
|
$ | 522 | $ | 439 | $ | 700 | $ | 598 | |||||||||||
|
Software license updates and product support:
|
|||||||||||||||||||
|
Revenues
|
$ | 1,252 | $ | 1,114 | $ | 2,427 | $ | 2,148 | |||||||||||
|
Cost of services
|
134 | 138 | 264 | 254 | |||||||||||||||
|
Margin(3)
|
$ | 1,118 | $ | 976 | $ | 2,163 | $ | 1,894 | |||||||||||
|
Total software business:
|
|||||||||||||||||||
|
Revenues(2)
|
$ | 2,221 | $ | 1,966 | $ | 3,957 | $ | 3,524 | |||||||||||
|
Expenses
|
581 | 551 | 1,094 | 1,032 | |||||||||||||||
|
Margin(3)
|
$ | 1,640 | $ | 1,415 | $ | 2,863 | $ | 2,492 | |||||||||||
|
Consulting:
|
|||||||||||||||||||
|
Revenues(2)
|
$ | 393 | $ | 395 | $ | 746 | $ | 789 | |||||||||||
|
Cost of services
|
317 | 320 | 625 | 649 | |||||||||||||||
|
Margin(3)
|
$ | 76 | $ | 75 | $ | 121 | $ | 140 | |||||||||||
|
Advanced product services:
|
|||||||||||||||||||
|
Revenues(2)
|
$ | 73 | $ | 65 | $ | 144 | $ | 125 | |||||||||||
|
Cost of services
|
55 | 56 | 106 | 102 | |||||||||||||||
|
Margin(3)
|
$ | 18 | $ | 9 | $ | 38 | $ | 23 | |||||||||||
|
Education:
|
|||||||||||||||||||
|
Revenues(2)
|
$ | 69 | $ | 72 | $ | 124 | $ | 132 | |||||||||||
|
Cost of services
|
56 | 56 | 100 | 103 | |||||||||||||||
|
Margin(3)
|
$ | 13 | $ | 16 | $ | 24 | $ | 29 | |||||||||||
|
Total services business:
|
|||||||||||||||||||
|
Revenues(2)
|
$ | 535 | $ | 532 | $ | 1,014 | $ | 1,046 | |||||||||||
|
Cost of services
|
428 | 432 | 831 | 854 | |||||||||||||||
|
Margin(3)
|
$ | 107 | $ | 100 | $ | 183 | $ | 192 | |||||||||||
|
Totals:
|
|||||||||||||||||||
|
Revenues
|
$ | 2,756 | $ | 2,498 | $ | 4,971 | $ | 4,570 | |||||||||||
|
Expenses
|
1,009 | 983 | 1,925 | 1,886 | |||||||||||||||
|
Margin(3)
|
$ | 1,747 | $ | 1,515 | $ | 3,046 | $ | 2,684 | |||||||||||
| (1) | For business and management evaluation purposes, the underlying structure of our operating segments change periodically. Segment data related to the prior periods have been reclassified, as required by Statement 131, to conform to the current management organizational structure. |
| (2) | Operating segment revenues differ from the external reporting classifications due to certain software license products that are classified as service revenues for management reporting purposes. |
| (3) | The margins reported reflect only the direct controllable expenses of each line of business and do not represent the actual margins for each operating segment because they do not contain an allocation of product development, information technology, marketing and partner programs and corporate and general and administrative expenses incurred in support of the lines of business. |
9
Reconciliation of operating segment margin to income before provision for income taxes
| Three Months Ended | Six Months Ended | ||||||||||||||||
| November 30, | November 30, | ||||||||||||||||
| (in millions) | 2004 | 2003 | 2004 | 2003 | |||||||||||||
|
Total margin for reportable segments
|
$ | 1,747 | $ | 1,515 | $ | 3,046 | $ | 2,684 | |||||||||
|
Product development and information technology
expenses
|
(387 | ) | (392 | ) | (760 | ) | (753 | ) | |||||||||
|
Marketing and partner program expenses
|
(91 | ) | (93 | ) | (173 | ) | (171 | ) | |||||||||
|
Corporate and general and administrative expenses
|
(130 | ) | (105 | ) | (250 | ) | (208 | ) | |||||||||
|
Other income, net
|
15 | (9 | ) | 29 | 28 | ||||||||||||
|
Income before provision for income taxes
|
$ | 1,154 | $ | 916 | $ | 1,892 | $ | 1,580 | |||||||||
| 8. | INCOME TAXES |
The effective tax rate in all periods is the result of the mix of income earned in various tax jurisdictions that apply a broad range of income tax rates. The provision for income taxes differs from the tax computed at the federal statutory income tax rate due primarily to state taxes and earnings considered as indefinitely reinvested in foreign operations.
The effective tax rate was 29.4% and 30.0% for the second quarter and first half of fiscal 2005 as compared to 32.6% and 33.1% for the corresponding prior year periods. The effective tax rate for the first half of fiscal 2005 on operating and other income was reduced to 30.0% in the second quarter from 31.0% in the first quarter. The decrease in the effective tax rate is attributable to higher earnings in low tax rate jurisdictions combined with a weakening dollar in those same jurisdictions. In fiscal 2004, the effective tax rate was a blend of the effective tax rate on operating and other income, increased by the tax rate on the gain from the sale of our investment in Liberate Technologies in the first quarter. The effective tax rate for the first half of fiscal 2004 on operating and other income was reduced to 33.0% in the second quarter from 33.5% in the first quarter.
The Internal Revenue Service has examined our federal income tax returns for all years through 1999 without any material adjustment of taxes due. The IRS is currently examining our federal income tax returns for 2000 through 2003. We do not believe that the outcome of these matters will have a material adverse effect on our consolidated financial position or results of operations.
Our intercompany transfer pricing is currently being reviewed by the IRS and by foreign tax jurisdictions and will likely be subject to additional audits in the future. We previously negotiated two Advance Pricing Agreements with the IRS that cover many of our intercompany transfer pricing issues and preclude the IRS from making a transfer pricing adjustment within the scope of these agreements. The agreements, however, are only effective through May 31, 2001, do not cover all elements of our intercompany transfer pricing issues and do not bind tax authorities outside the United States. We are currently negotiating bilateral and unilateral Advance Pricing Agreements to cover periods beyond June 1, 2001.
10
On October 22, 2004, the President of the United States signed into law the American Jobs Creation Act of 2004 replacing the extraterritorial income (ETI) tax incentive with a deduction for production. In the long term we expect this new deduction to provide a similar tax benefit as the ETI tax incentive has in the past. We may have a small reduction in our fiscal year 2005 tax benefit as the transition rules create a short-term gap in the benefit we receive.
The American Jobs Creation Act also introduced a special one-time dividends received deduction on the repatriation of certain foreign earnings, provided certain criteria are met. However, until the Treasury Department or Congress provides additional clarifying language on key elements of the repatriation provision, we will not be able to determine the amount of foreign earnings we would repatriate. We will complete our evaluation after the government has provided the necessary guidance. The maximum amount available for repatriation is $3.1 billion and the additional income tax associated with the maximum amount ranges from $100 to $300 million.
As discussed in Note 9, we entered into an Agreement and Plan of Merger with PeopleSoft, Inc., a Delaware corporation on December 12, 2004. Costs incurred with our tender offer for PeopleSoft prior to the date of this agreement have been expensed in our consolidated statements of operations. At November 30, 2004, we had deferred tax assets associated with these costs of approximately $44 million. As we now expect the merger to be completed, these costs will no longer be deductible for tax purposes, and therefore, we expect these costs will increase our income tax expense in the third quarter of fiscal 2005.
| 9. | TENDER OFFER FOR PEOPLESOFT, INC. |
On June 9, 2003, we commenced an unsolicited tender offer for all of the outstanding shares of common stock of PeopleSoft. We have since amended and extended the offer on numerous occasions.
On December 12, 2004, we and our acquisition subsidiary entered into an Agreement and Plan of Merger with PeopleSoft, increased our offer price to $26.50 per share and amended the expiration date of our offer to December 28, 2004. We expect that we will need approximately $10.3 billion to purchase all shares that we estimate will be outstanding prior to the expiration of the tender offer and to pay estimated fees and expenses. The offer will be extended if less than a majority of the total number of shares of PeopleSoft common stock outstanding on a fully diluted basis have been tendered and not withdrawn at the expiration date. Following the conclusion of the offer, the remaining holders of issued and outstanding shares of PeopleSoft common stock will receive $26.50 per share and our acquisition subsidiary will be merged with and into PeopleSoft. In addition, options to acquire shares of PeopleSoft that are outstanding prior to the consummation of the merger will be converted into options to acquire shares of Oracle common stock based on a formula provided in the merger agreement.
On December 24, 2003, we entered into a 364-Day Revolving Credit Facility (the Credit Facility) with Credit Suisse First Boston (an affiliate of Credit Suisse First Boston LLC) and certain other syndicated lenders named in the Credit Facility. The Credit Facility provides an unsecured revolving credit facility to us or an acquisition subsidiary, with the underlying obligation guaranteed by us, in the aggregate amount of up to $1.5 billion and is available through December 22, 2004 for the purpose of financing the acquisition of PeopleSoft. At November 30, 2004, no amounts were borrowed under the Credit Facility. We are currently discussing additional credit facilities with lenders.
From the inception of our tender offer for PeopleSoft in June 2003 to November 30, 2004, we have incurred approximately $111.5 million of expenditures. We incurred expenditures of $23.3 million and $51.8 million for the three and six months ended November 30, 2004 and $13.8 million and $28.4 million for the three and six months ended November 30, 2003. These costs are included in general and administrative expense in the
11
condensed consolidated statements of operations. We also incurred $5.0 million of commitment fees for the Credit Facility, which is included in other income, net in the condensed consolidated statements of operations in the six months ended November 30, 2003.
As discussed in Note 10, in connection with the tender offer, we have been named as a defendant in various legal proceedings and may be a party to additional legal proceedings in the future.
| 10. | LEGAL PROCEEDINGS |
Stockholder class actions were filed in the United States District Court for the Northern District of California against us and our Chief Executive Officer on and after March 9, 2001. On June 20, 2001, the court consolidated the class actions into a single action and appointed a lead plaintiff and class counsel. A consolidated amended complaint, adding our then Chief Financial Officer (who currently is Chairman of our Board of Directors) and a former Executive Vice President as defendants, was filed on August 3, 2001. The consolidated amended complaint was brought on behalf of purchasers of our stock during the period from December 15, 2000 through March 1, 2001. Plaintiffs alleged that the defendants made false and misleading statements about our actual and expected financial performance and the performance of certain of our applications products, while certain individual defendants were selling Oracle stock in violation of federal securities laws. Plaintiffs further alleged that certain individual defendants sold Oracle stock while in possession of material non-public information. On March 12, 2002, the court granted our and the individual defendants’ motion to dismiss the amended consolidated complaint. On April 10, 2002, plaintiffs filed a first amended consolidated complaint, brought on behalf of purchasers of our stock during the period from December 14, 2000 through March 1, 2001. On September 11, 2002, the court granted defendants’ motion to dismiss that complaint. On October 11, 2002, the plaintiffs filed a second amended complaint. In this second amended complaint, the plaintiffs added allegations that the defendants engaged in accounting violations and made misstatements about our financial performance, beginning on December 14, 2000 through March 1, 2001. On March 24, 2003, the court dismissed the second amended complaint with prejudice. Plaintiffs appealed that dismissal and, on September 1, 2004, the United States Court of Appeals for the Ninth Circuit reversed the dismissal order and remanded the case for further proceedings. The Company and the individual defendants petitioned for rehearing of the Ninth Circuit’s decision, and on October 21, 2004, the petition for rehearing was denied. A trial date has been set for September 11, 2006. We believe that we have meritorious defenses against this action and we will continue to vigorously defend it. No class has been certified.
Stockholder derivative lawsuits were filed in the Court of Chancery in the State of Delaware in and for New Castle County on and after March 12, 2001. A revised amended consolidated complaint was filed in the Delaware action on October 9, 2001 (the Delaware Derivative Action). During the same period, similar stockholder derivative lawsuits were filed in the Superior Court of the State of California, County of San Mateo and County of Santa Clara. A consolidated amended complaint was filed in San Mateo Superior Court on January 28, 2002 (the San Mateo Derivative Action). On March 15, 2002, a similar derivative suit was filed in the United States District Court for the Northern District of California (the Federal Derivative Action). The derivative suits were brought by alleged stockholders of Oracle, purportedly on our behalf, against some of our current and former directors. The derivative plaintiffs alleged that these directors breached their fiduciary duties to us, abused their control, mismanaged Oracle, unjustly enriched themselves, committed constructive fraud and breached contracts with us, by making or causing to be made alleged misstatements about our revenue, growth and the performance of certain of our applications products, while certain officers and directors allegedly sold Oracle stock based on material, non-public information, and by taking actions that resulted in our being sued in the federal stockholder class actions. The derivative plaintiffs seek compensatory and other damages, disgorgement of profits, treble damages and other relief. Plaintiffs filed a motion to amend the complaint in the Delaware Derivative Action to dismiss all defendants other than our
12
Chief Executive Officer and our then Chief Financial Officer which was granted by a stipulation of all the parties and order of the court on September 23, 2003. The two remaining defendants filed a motion for summary judgment seeking judgment in their favor on all claims in the Delaware Action. Plaintiffs’ opposition to the summary judgment motion was filed on June 15, 2004, and the defendants filed reply papers on July 16, 2004. On September 2 and 3, 2004, the Delaware court conducted a hearing on the summary judgment motion. On November 24, 2004, the Delaware Court issued an opinion, granting the summary judgment motion, and dismissing all of plaintiffs’ claims in the Delaware Action.
Regarding the San Mateo and Federal Derivative Actions, on April 18, 2003, the San Mateo Court dismissed plaintiffs’ claim for breach of contract. On December 8, 2003, the San Mateo Court approved plaintiffs’ request in the San Mateo Derivative Action to dismiss all defendants other than our Chief Executive Officer and our then Chief Financial Officer. Also, pursuant to a stipulation of the parties and order of the San Mateo Court, all causes of action, except the cause of action brought under the California Corporation Code, have been dismissed and instead will be adjudicated in the Delaware Derivative Action. Our subsequent motion for a judgment on the pleadings as to the remaining cause of action was denied. On March 24, 2004, the director-defendants filed a petition for a writ of mandate in the Court of Appeal of the State of California, First Appellate District, seeking an order requiring the San Mateo Superior Court to dismiss the remaining cause of action. On April 22, 2004, Oracle filed a similar writ petition. On June 17, 2004, the Court of Appeal consolidated these two writ proceedings, and on July 2, 2004, plaintiffs filed opposition papers. On July 12, 2004, the director-defendants filed reply papers. On September 30, 2004, the Court of Appeal summarily denied these petitions. On October 8, 2004, both the direct-defendants and the Company filed petitions for writ of review in the California Supreme Court, seeking either an order requiring the Court of Appeal to issue a decision on the merits of the writ of mandate petitions or, in the alternative, an order requiring the San Mateo Court to dismiss the remaining cause of action. Plaintiffs filed opposition papers on October 28, 2004, and the director-defendants filed reply papers on November 8, 2004. On December 1, 2004, the California Supreme Court denied the petitions for writ of review. The trial date previously set for April 5, 2004 has been postponed, and we do not expect trial to proceed before 2005, at the earliest. On March 5, 2004, the Northern District Court issued an order dismissing all defendants other than our Chief Executive Officer and Chief Financial Officer from the Federal Derivative Action. The Federal Derivative Action has been stayed by stipulation of the parties. Any party may terminate the stay with 30 days written notice.
On July 29, 1998, and on November 22, 2002, we filed petitions with the United States Tax Court, challenging notices of deficiency issued by the Commissioner of Internal Revenue that disallowed certain Foreign Sales Corporation (FSC) commission expense deductions taken by us. The first notice of deficiency covered our 1988 through 1991 tax years and assessed additional taxes of approximately $20 million plus interest. The second notice covered our 1992 through 1995 tax years and assessed additional taxes of approximately $43 million plus interest. In February 2003, the IRS conceded its case against us for tax years 1992 through 1995 and on May 8, 2003, the Court ordered there were no further deficiencies for those years. Similarly, in a joint status report filed with the Tax Court in May 2004, the IRS conceded the FSC issue for tax years 1988 through 1991. We are still in the process of negotiating the final computations for a settlement with respect to those years and anticipate this matter will be resolved in our favor without further trial proceedings.
In connection with our unsolicited offer for PeopleSoft, we have been involved in several legal proceedings and may be party to additional legal proceedings in the future:
| • | Antitrust litigation brought against us by the U.S. Department of Justice and numerous states concluded in September 2004 with a final judgment in our favor, and the governments concluded not to appeal this judgment. |
13
| • | We initiated legal proceedings on June 18, 2003 against PeopleSoft and its board of directors in the Court of Chancery of the State of Delaware alleging breach of fiduciary duty and other claims. | |
| • | In June 2003, PeopleSoft filed suit against us in the Superior Court of the State of California, County of Alameda, alleging unlawful interference, trade libel and false advertising. |
Pursuant to the merger agreement described in Note 9, we and PeopleSoft have agreed to enter into stipulations staying all litigation currently pending between us and our respective affiliates and representatives in connection with our tender offer, and to dismiss such litigations with prejudice once our representatives constitute a majority of PeopleSoft’s board.
We are currently party to various legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these matters cannot be predicted with certainty, we do not believe that the outcome of any of these claims or any of the above mentioned legal matters will have a material adverse effect on our consolidated financial position, results of operations, or cash flow.
| 11. | NEW ACCOUNTING PRONOUNCEMENTS |
Share-Based Payment
On December 16, 2004, the FASB issued Statement No. 123 (revised 2004), Share-Based Payment. Statement 123(R) would require us to measure all employee stock-based compensation awards using a fair value method and record such expense in our consolidated financial statements. In addition, the adoption of Statement 123(R) will require additional accounting related to the income tax effects and additional disclosure regarding the cash flow effects resulting from share-based payment arrangements. Statement 123(R) is effective beginning in our second quarter of fiscal 2006. The adoption of Statement 123(R) could have a material impact on our consolidated financial position, results of operations and cash flows.
Exchanges of Nonmonetary Assets
On December 16, 2004, the FASB issued Statement No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29. Statement 153 addresses the measurement of exchanges of nonmonetary assets and redefines the scope of transactions that should be measured based on the fair value of the assets exchanged. Statement 153 is effective for nonmonetary asset exchanges beginning in our second quarter of fiscal 2006. We do not believe adoption of Statement 153 will have a material effect on our consolidated financial position, results of operations or cash flows.
Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004
On December 21, 2004, the FASB issued FASB Staff Position No. FAS 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004. The American Jobs Creation Act introduces a special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer (repatriation provision), provided certain criteria are met. FSP FAS 109-2 provides accounting and disclosure guidance for the repatriation provision. Although FSP FAS 109-2 is effective immediately, until the Treasury Department or Congress provides additional clarifying language on key elements of the repatriation provision, we will not be able to determine the amount of foreign earnings we would repatriate. We will complete our evaluation after the government has provided the necessary guidance. The maximum amount available for repatriation is $3.1 billion and the additional income tax associated with the maximum amount ranges from $100 to $300 million.
14
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
We begin Management’s Discussion and Analysis of Financial Condition and Results of Operations with an overview of our key operating business segments and significant trends. This overview is followed by a discussion of our critical accounting policies and estimates that we believe are important to understanding the assumptions and judgments incorporated in our reported financial results. We then provide a more detailed analysis of our financial condition and results of operations.
In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties that could cause our actual results to differ materially. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations— Factors That May Affect Our Future Results or the Market Price of Our Stock.” When used in this report, the words “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions are generally intended to identify forward-looking statements. You should not place undue reliance on these forward-looking statements, which reflect our opinions only as of the date of this Quarterly Report. We undertake no obligation to publicly release any revisions to the forward-looking statements after the date of this document. You should carefully review the risk factors described in other documents we file from time to time with the Securities and Exchange Commission, including the Annual Report on Form 10-K for the fiscal year ended May 31, 2004 and the other Quarterly Reports on Form 10-Q filed by us in our fiscal year 2005, which runs from June 1, 2004 to May 31, 2005.
Overview
We are the world’s largest enterprise software company. Our worldwide operations are comprised of two businesses, which consist of five operating segments based upon our software and service offerings. Each of these operating segments has unique characteristics and faces different opportunities and challenges. Although we report our actual results in United States dollars, we conduct a significant number of transactions in currencies other than United States dollars. Therefore, we present constant currency information to provide a framework for assessing how our underlying business performed excluding the effect of foreign currency rate fluctuations. An overview of our five operating segments follows.
Software Business
New Software Licenses: We license our database technology software and applications software to businesses of many sizes, government agencies, educational institutions and resellers. The growth in new software license revenues is affected by the strength of general economic and business conditions, as well as governmental budgetary constraints, and the competitive position of our software products. The software business is also characterized by long sales cycles. The timing of a few large software license transactions can substantially affect our quarterly new software license revenues. This is particularly true for applications products given the relative small size of new application software license revenues. Since our new software license revenues in a particular quarter can be difficult to predict as a result of the timing of a few large software license transactions, we believe that new software revenues on a trailing twelve-month period provides more visibility into the underlying performance of our software revenues than quarterly revenues. New software license revenues on a trailing twelve-month basis were $3.7 billion, which represents a growth rate of 11% over the corresponding prior year period. Over the last few years, customers delayed or limited their technology capital spending as a result of weak domestic and international economic conditions. These weak economic conditions resulted in more customers restricting their software procurement to well-defined current needs and a decline in purchases intended to accommodate future customer growth. We believe that demand for our software products will continue to increase as a result of the improvements we have made to the features and functionality of our software products and as the global economy continues to improve.
Competition in the software business is intense. Our goal is to maintain a first or second position in each of our software product categories and to grow our software revenues faster than our competitors. We believe that the features and functionality of our software products are as strong as they have ever been. We have focused on
15
Software License Updates and Product Support: Substantially all of our customers purchase software license updates and product support when they acquire new software licenses. In addition, a substantial majority of our customers renew their software license updates and product support contracts annually. The growth of software license updates and product support is influenced by two factors: the renewal rate of the subscription base eligible for renewal in the current quarter and the amount of new product support contracts associated with the sale of new software licenses. As our product support subscription base grows, the renewal rate has a larger influence on the software license updates and product support revenue growth rate and the amount of new software license revenues has a diminishing effect. Therefore, the growth rate of software license updates and product support revenues do not necessarily correlate directly to the growth rate of new software license revenues. For example, if new software license revenues remained constant, license updates and product support revenues would continue to grow as a result of the incremental license updates and product support revenues associated with new software license revenues, assuming renewal and cancellation rates stayed relatively constant. We believe that software license updates and product support revenues will continue to grow as we anticipate that a substantial majority of our customers will renew their product support contracts and the sale of new software license will increase our subscription base.
Services Business
Consulting: Consulting revenues tend to lag software revenues by several quarters since consulting services, if purchased, are typically performed after the purchase of software licenses. In recent periods, consulting revenues have declined due to a shift in the mix of resources to lower cost countries, which has resulted in a decrease in billing rates. Consulting revenues also declined as a result of our working more closely with partners, who are performing an increasing number of the implementations of our software. In addition, we have experienced higher attrition rates in the United States and certain other countries as global economic conditions improve and the demand for technical talent in certain markets has increased. The higher attrition rate has contributed to the decrease in consulting headcount levels, which has resulted in a decline in billable hours and revenues. We expect consulting revenues to decline for the remainder of fiscal 2005, but at a lower rate than the first half, because of our continued repositioning to lower cost geographies as well as an increasing use of systems integration partners.
Advanced Product Services: This segment includes Oracle On Demand, which is our outsourcing service, and other advanced product support services. We believe that Oracle On Demand provides an additional opportunity for customers to lower their total cost of ownership and can therefore provide us with a competitive advantage. Although we have de-emphasized some advanced product services, Oracle On Demand revenues continue to grow. We will continue to make investments in our Oracle On Demand business to support current and future revenue growth.
Education: The purpose of our education services is to further enhance the usability of our software products by our customers and to create opportunities to grow new software license revenues. Personnel reductions in our customers’ information technology departments, tighter controls over discretionary spending and greater use of outsourcing solutions have caused substantial declines in education revenues since fiscal 2000. As a consequence, we have reduced the number of personnel and facilities space in order to reduce costs and prevent further margin deterioration.
Liquidity
We continue to believe that the best use of our excess cash is to use it to grow our business and then to buy back stock. We continue to evaluate the efficacy of dividends versus stock repurchases.
16
We generate substantial cash flows from our operating activities. The repurchase of shares of our common stock over the past few years has more than offset the dilutive effect of our stock option and stock purchase plans.
Acquisition Strategy
We have in the past and expect in the future to acquire or make investments in complementary companies, products, services and technologies. We believe we could fund acquisitions with our internally available cash and investments, cash generated from operations, credit facilities or from the issuance of additional securities. We analyze the financial impact of any potential acquisition to ensure that it will meet our earnings, operating margin, cash flow, and return on invested capital targets.
On December 12, 2004, we and our acquisition subsidiary entered into an Agreement and Plan of Merger with PeopleSoft, increased our offer price to $26.50 per share and amended the expiration date of our offer to December 28, 2004. We expect that we will need approximately $10.3 billion to purchase all shares that we estimate will be outstanding prior to the expiration of the tender offer and to pay estimated fees and expenses. We have a $1.5 billion unsecured revolving credit facility available through December 22, 2004, for the acquisition of PeopleSoft. In addition to the credit facility, we could raise funds through additional borrowings or from the issuance of additional securities. We expect, based upon the combination of internally available cash and investments as of November 30, 2004, additional cash generated since that date, borrowings under the $1.5 billion credit facility or any other credit facility or the issuance of securities, to have sufficient cash on hand at the expiration of the offer to pay the offer price for all shares in the offer. The offer is not conditioned upon any financing arrangements.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP). These accounting principles require us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenues and expenses during the periods presented. To the extent there are material differences between these estimates, judgments or assumptions and actual results, our financial statements will be affected. The accounting policies that reflect our more significant estimates, judgments and assumptions and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:
| • | Revenue Recognition | |
| • | Allowances for Doubtful Accounts and Returns | |
| • | Legal Contingencies | |
| • | Accounting for Income Taxes |
In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application. There are also areas in which management’s judgment in selecting among available alternatives would not produce a materially different result. Our senior management has reviewed these critical accounting policies and related disclosures with our Finance and Audit Committee.
Revenue Recognition
We derive revenues from the following sources: (1) software, which includes new software license and software license updates and product support revenues and (2) services, which include consulting, advanced product services and education revenues.
17
New software license revenues represent all fees earned from granting customers licenses to use our database technology and applications software, and exclude revenues derived from software license updates, which are included in software license updates and product support. While the basis for software license revenue recognition is substantially governed by the provisions of Statement of Position No. 97-2, Software Revenue Recognition, issued by the American Institute of Certified Public Accountants, we exercise judgment and use estimates in connection with the determination of the amount of software and services revenues to be recognized in each accounting period.
For software license arrangements that do not require significant modification or customization of the underlying software, we recognize new software license revenue when: (1) we enter into a legally binding arrangement with a customer for the license of software; (2) we deliver the products; (3) customer payment is deemed fixed or determinable and free of contingencies or significant uncertainties; and (4) collection is probable. Substantially all of our new software license revenues are recognized in this manner.
The vast majority of our software license arrangements include software license updates and product support, which are recognized ratably over the term of the arrangement, typically one year. Software license updates provide customers with rights to unspecified software product upgrades, maintenance releases and patches released during the term of the support period. Product support includes internet access to technical content, as well as internet and telephone access to technical support personnel. Software license updates and product support are generally priced as a percentage of the net new software license fees. Software license updates can be purchased separately from product support; however, only customers who purchase software license updates can purchase product support. Substantially all of our customers purchase both software license updates and product support when they acquire new software licenses. In addition, substantially all of our customers renew the software license updates and product support contracts annually.
Many of our software arrangements include consulting implementation services sold separately under consulting engagement contracts. Consulting revenues from these arrangements are generally accounted for separately from new software license revenues because the arrangements qualify as service transactions as defined in SOP 97-2. The more significant factors considered in determining whether the revenue should be accounted for separately include the nature of services (i.e., consideration of whether the services are essential to the functionality of the licensed product), degree of risk, availability of services from other vendors, timing of payments and impact of milestones or acceptance criteria on the realizability of the software license fee. Revenues for consulting services are generally recognized as the services are performed. If there is a significant uncertainty about the project completion or receipt of payment for the consulting services, revenue is deferred until the uncertainty is sufficiently resolved. We estimate the percentage of completion on contracts with fixed or “not to exceed” fees on a monthly basis utilizing hours incurred to date as a percentage of total estimated hours to complete the project. We recognize no more than 90% of the milestone or total contract amount until project acceptance is obtained. If we do not have a sufficient basis to measure progress towards completion, revenue is recognized when we receive final acceptance from the customer. When total cost estimates exceed revenues, we accrue for the estimated losses immediately using cost estimates that are based upon an average fully burdened daily rate applicable to the consulting organization delivering the services. The complexity of the estimation process and factors relating to the assumptions, risks and uncertainties inherent with the application of the percentage-of-completion method of accounting affect the amounts of revenue and related expenses reported in our consolidated financial statements. A number of internal and external factors can affect our estimates, including labor rates, utilization and efficiency variances and specification and testing requirement changes.
If an arrangement does not qualify for separate accounting of the software license and consulting transactions, then new software license revenue is generally recognized together with the consulting services based on contract accounting using either the percentage-of-completion or completed-contract method. Contract accounting is applied to any arrangements: (1) that include milestones or customer specific acceptance criteria that may affect collection of the software license fees; (2) where services include significant modification or customization of the software; (3) where significant consulting services are provided for in the software license contract without additional charge or are substantially discounted; or (4) where the software license payment is tied to the performance of consulting services.
18
Advanced product services are comprised of Oracle On Demand and advanced product support services. Oracle On Demand provides multi-featured software and hardware management and maintenance services for our database technology and applications software. Advanced product support services are earned by providing customers configuration and performance analysis, personalized support and annual on-site technical services. Advanced product services revenues are recognized over the term of the service contract, which is generally one year.
Education revenues include instructor-led, media-based and internet-based training in the use of our products. Education revenues are recognized as the classes or other education offerings are delivered.
For arrangements with multiple elements, we allocate revenue to each element of a transaction based upon its fair value as determined by “vendor specific objective evidence.” Vendor specific objective evidence of fair value for all elements of an arrangement is based upon the normal pricing and discounting practices for those products and services when sold separately and for software license updates and product support services, is additionally measured by the renewal rate offered to the customer. We may modify our pricing practices in the future, which could result in changes in our vendor specific objective evidence of fair value for these undelivered elements. As a result, our future revenue recognition for multi-element arrangements could differ significantly from our historical results.
We defer revenue for any undelivered elements, and recognize revenue when the product is delivered or over the period in which the service is performed, in accordance with our revenue recognition policy for such element. If we cannot objectively determine the fair value of any undelivered element included in bundled software and service arrangements, we defer revenue until all elements are delivered and services have been performed, or until fair value can objectively be determined for any remaining undelivered elements. When the fair value of a delivered element has not been established, we use the residual method to record revenue if the fair value of all undelivered elements is determinable. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is allocated to the delivered elements and is recognized as revenue.
Our software license arrangements generally do not include acceptance provisions. However, if acceptance provisions exist as part of public policy, for example in agreements with government entities when acceptance periods are required by law, or within previously executed terms and conditions that are referenced in the current agreement and are short-term in nature, we provide for a sales return allowance in accordance with FASB Statement No. 48, Revenue Recognition when Right of Return Exists. If acceptance provisions are long-term in nature or are not included as standard terms of an arrangement or if we cannot reasonably estimate the incidence of returns, revenue is recognized upon the earlier of receipt of written customer acceptance or expiration of the acceptance period.
We also evaluate arrangements with governmental entities containing “fiscal funding” or “termination for convenience” provisions, when such provisions are required by law, to determine the probability of possible cancellation. We consider multiple factors, including the history with the customer in similar transactions, the “essential use” of the software licenses and the planning, budgeting and approval processes undertaken by the governmental entity. If we determine upon execution of these arrangements that the likelihood of non-acceptance is remote, we then recognize revenue once all of the criteria described above have been met. If such a determination cannot be made, revenue is recognized upon the earlier of cash receipt or approval of the applicable funding provision by the governmental entity.
We assess whether fees are fixed or determinable at the time of sale and recognize revenue if all other revenue recognition requirements are met. Our standard payment terms are net 30; however, terms may vary based on the country in which the agreement is executed. Payments that are due within six months are generally deemed to be fixed or determinable based on our successful collection history on such arrangements, and thereby satisfy the required criteria for revenue recognition.
While most of our arrangements include short-term payment terms, we have a standard practice of providing long-term financing to credit worthy customers through our financing division. Since fiscal 1989, when our financing division was formed, we have established a history of collection, without concessions, on these
19
Allowances for Doubtful Accounts and Returns
We make judgments as to our ability to collect outstanding receivables and provide allowances for the portion of receivables when collection becomes doubtful. Provisions are made based upon a specific review of all significant outstanding invoices. For those invoices not specifically reviewed, provisions are provided at differing rates, based upon the age of the receivable. In determining these percentages, we analyze our historical collection experience and current economic trends. If the historical data we use to calculate the allowance for doubtful accounts does not reflect the future ability to collect outstanding receivables, additional provisions for doubtful accounts may be needed and the future results of operations could be materially affected.
We also record a provision for estimated sales returns and allowances on product and service related sales in the same period the related revenues are recorded in accordance with Statement 48. These estimates are based on historical sales returns, analysis of credit memo data and other known factors. If the historical data we use to calculate these estimates do not properly reflect future returns, then a change in the allowances would be made in the period in which such a determination is made and revenues in that period could be materially affected.
Legal Contingencies
We are currently involved in various claims and legal proceedings. Quarterly, we review the status of each significant matter and assess our potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Significant judgment is required in both the determination of probability and the determination as to whether an exposure is reasonably estimable. Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, we reassess the potential liability related to our pending claims and litigation and may revise our estimates. Such revisions in the estimates of the potential liabilities could have a material impact on our results of operations and financial position.
Accounting for Income Taxes
Significant judgment is required in determining our worldwide income tax provision. In the ordinary course of a global business, there are many transactions and calculations where the ultimate tax outcome is uncertain. Some of these uncertainties arise as a consequence of revenue sharing and cost reimbursement arrangements among related entities, the process of identifying items of revenue and expense that qualify for preferential tax treatment, and segregation of foreign and domestic income and expense to avoid double taxation. Although we believe that our estimates are reasonable, no assurance can be given that the final tax outcome of these matters will not be different than that which is reflected in our historical income tax provisions and accruals. Such differences could have a material effect on our income tax provision and net income in the period in which such determination is made.
We record a valuation allowance to reduce our deferred tax assets to the amount of future tax benefit that is more likely than not to be realized. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, there is no assurance that the valuation allowance will not need to be increased to cover additional deferred tax assets that may not be
20
We provide for United States income taxes on the earnings of foreign subsidiaries unless they are considered indefinitely reinvested outside the United States. If these earnings were repatriated to the United States, they would generate foreign tax credits that could reduce the Federal tax liability associated with the foreign dividend.
Results of Operations
Constant Currency Presentation
We compare the percent change in the results from one period to another period in this Quarterly Report using constant currency disclosure. We present constant currency information to provide a framework for assessing how our underlying businesses performed excluding the effect of foreign currency rate fluctuations. To present this information, current and comparative prior period results for entities reporting in currencies other than United States dollars are converted into United States dollars at the exchange rate in effect on the last day of the prior fiscal year, rather than the actual exchange rates in effect during the respective periods. For example, if an entity reporting in Euros had revenues of 1.0 million Euros from products sold on November 30, 2004 and 2003, our financial statements would reflect revenues of $1.3 million for the six months ended November 30, 2004 (using 1.31 as the exchange rate) and $1.2 million for the six months ended November 30, 2003 (using 1.18 as the exchange rate). The constant currency presentation would translate the results for the six months ended November 30, 2004 and 2003 using the May 31, 2004 exchange rate and indicate, in this example, no change in revenues during the periods. In each of the tables below, we present the percent change based on actual results as reported and based on constant currency.
Total Revenues and Operating Expenses
| Three Months Ended November 30, | Six Months Ended November 30, | ||||||||||||||||||||||||
| Percent Change | Percent Change | ||||||||||||||||||||||||
| (Dollars in millions) | 2004 | Actual | Constant | 2003 | 2004 | Actual | Constant | 2003 | |||||||||||||||||
|
Total Revenues:
|
|||||||||||||||||||||||||
|
Americas
|
$ | 1,292 | 3% | 3% | $ | 1,250 | $ | 2,384 | 4% | 4% | $ | 2,292 | |||||||||||||
|
EMEA(1)
|
1,062 | 21% | 10% | 881 | 1,839 | 15% | 6% | 1,598 | |||||||||||||||||
|
Asia Pacific
|
402 | 10% | 6% | 367 | 748 | 10% | 5% | 680 | |||||||||||||||||
|
Total revenues
|
2,756 | 10% | 6% | 2,498 | 4,971 | 9% | 5% | 4,570 | |||||||||||||||||
|
Total Operating Expenses
|
1,625 | 3% | -1% | 1,583 | 3,126 | 3% | 0% | 3,039 | |||||||||||||||||
|
Total Operating Margin
|
$ | 1,131 | 24% | 17% | $ | 915 | $ | 1,845 | 21% | 14% | $ | 1,531 | |||||||||||||
|
Total Operating Margin %
|
41% | 37% | 37% | 34% | |||||||||||||||||||||
|
% Revenues by Geography:
|
|||||||||||||||||||||||||
|
Americas
|
47% | 50% | 48% | 50% | |||||||||||||||||||||
|
EMEA
|
38% | 35% | 37% | 35% | |||||||||||||||||||||
|
Asia Pacific
|
15% | 15% | 15% | 15% | |||||||||||||||||||||
|
Total Revenues by Business:
|
|||||||||||||||||||||||||
|
Software
|
$ | 2,223 | 13% | 9% | $ | 1,969 | $ | 3,961 | 12% | 8% | $ | 3,528 | |||||||||||||
|
Services
|
$ | 533 | 1% | -3% | $ | 529 | $ | 1,010 | -3% | -7% | $ | 1,042 | |||||||||||||
|
% Revenues by Business:
|
|||||||||||||||||||||||||
|
Software
|
81% | 79% | 80% | 77% | |||||||||||||||||||||
|
Services
|
19% | 21% | 20% | 23% | |||||||||||||||||||||
|
|
| (1) | Comprised of Europe, the Middle East and Africa |
21
Fiscal Second Quarter 2005 Compared to Fiscal Second Quarter 2004: Excluding foreign currency rate fluctuations, total revenues increased in the second quarter of fiscal 2005 due to an increase in both new software license revenues and software license updates and product support revenues, partially offset by lower services revenues, most notably consulting revenues. Revenues were favorably affected by foreign currency rate fluctuations due to a weakening of the United States dollar against certain major international currencies, primarily the Euro, British Pound and Japanese Yen.
Solid sales execution across all regions and increased demand for our software license products contributed to the growth in new software license revenues. The increase in software license updates and product support revenues is a result of the renewal of a substantial majority of the subscription base eligible for renewal in the current quarter, the addition of software license updates and product support revenues associated with new software license revenues recognized in the last twelve months and more timely contract renewals.
In the second quarter of fiscal 2005, consulting revenues declined due to a shift in the mix of resources to lower cost countries, increased use of our partners performing implementations and higher attrition in the United States, which resulted in a decline in billable hours. Advanced product services revenues increased primarily due to an expansion of our subscription base for Oracle On Demand services. Education revenues declined due to a reduction in demand for education services. Excluding the effect of currency rate fluctuations, the Americas contributed 23% to the increase in total revenues, EMEA contributed 63% and Asia Pacific contributed 14%.
Operating expenses were unfavorably affected as a result of the weakening of the United States dollar relative to other major international currencies. Excluding currency rate fluctuations, the decline in total operating expenses was primarily due to the release of a $23.0 million legal reserve as the result of a favorable judgment in a legal proceeding that became final during the quarter, which was partially offset by a $9.5 million increase in professional fees incurred in connection with the PeopleSoft tender offer.
Operating margins as a percentage of total revenues increased from 37% to 41% due to higher new software license revenues and software license updates and product support revenues.
International operations will continue to provide a significant portion of total revenues. As a result, total revenues and expenses will be affected by changes in the relative strength of the United States dollar against certain major international currencies.
First Half Fiscal 2005 Compared to First Half Fiscal 2004: The growth in total revenues in the first half of fiscal 2005 is attributed to the same reasons noted above. Revenues were favorably affected by foreign currency rate fluctuations due to a weakening of the United States dollar against certain major international currencies, primarily the Euro, British Pound and Japanese Yen. Excluding the effect of currency rate fluctuations, the Americas contributed 38% to the increase in total revenues, EMEA contributed 45% and Asia Pacific contributed 17%.
Operating expenses were unfavorably affected as a result of the weakening of the United States dollar relative to other major international currencies. Excluding currency rate fluctuations, total operating expenses remained essentially flat as compared to the prior year corresponding period, primarily due to the release of a $23.0 million legal reserve as the result of a favorable judgment in a legal proceeding that became final during the quarter. Excluding this adjustment, total operating expenses increased primarily due to a $23.4 million increase in professional fees incurred in connection with the PeopleSoft tender offer.
Operating margins as a percentage of total revenues increased from 34% to 37% due to higher new software license revenues and software license updates and product support revenues.
22
Software Business
Our software business includes new software licenses and software license updates and product support.
New Software Licenses: New software license revenues represent fees earned from granting customers licenses to use our database technology and application software products, and exclude revenues derived from software license updates, which are included in software license updates and product support revenues. New software license revenues also include other revenues, which consist of documentation and miscellaneous revenues. We continue to place significant emphasis, both domestically and internationally, on direct sales through our own sales force. We also continue to market our products through indirect channels.
| Three Months Ended November 30, | Six Months Ended November 30, | ||||||||||||||||||||||||
| Percent Change | Percent Change | ||||||||||||||||||||||||
| (Dollars in millions) | 2004 | Actual | Constant | 2003 | 2004 | Actual | Constant | 2003 | |||||||||||||||||
|
New Software License
Revenues:
|
|||||||||||||||||||||||||
|
Americas
|
$ | 405 | 7% | 7% | $ | 377 | $ | 637 | 9% | 8% | $ | 587 | |||||||||||||
|
EMEA
|
385 | 23% | 13% | 312 | 572 | 12% | 3% | 512 | |||||||||||||||||
|
Asia Pacific
|
181 | 9% | 6% | 166 | 325 | 16% | 11% | 281 | |||||||||||||||||
|
Total revenues
|
971 | 14% | 9% | 855 | 1,534 | 11% | 7% | 1,380 | |||||||||||||||||
|
Sales and Marketing Expenses
|
555 | 6% | 2% | 525 | 1,035 | 5% | 1% | 989 | |||||||||||||||||
|
Total Margin
|
$ | 416 | 26% | 20% | $ | 330 | $ | 499 | 28% | 21% | $ | 391 | |||||||||||||
|
Total Margin %
|
43% | 39% | 33% | 28% | |||||||||||||||||||||
|
% Revenues by Geography:
|
|||||||||||||||||||||||||
|
Americas
|
42% | 44% | 42% | 43% | |||||||||||||||||||||
|
EMEA
|
40% | 37% | 37% | 37% | |||||||||||||||||||||
|
Asia Pacific
|
18% | 19% | 21% | 20% | |||||||||||||||||||||
|
Revenues by Product:
|
|||||||||||||||||||||||||
|
Database technology
|
$ | 749 | 5% | 1% | $ | 712 | $ | 1,235 | 10% | 6% | $ | 1,119 | |||||||||||||
|
Applications
|
215 | 57% | 51% | 137 | 283 | 16% | 12% | 244 | |||||||||||||||||
|
Total revenues by product
|
964 | 14% | 9% | 849 | 1,518 | 11% | 7% | 1,363 | |||||||||||||||||
|
Other revenues
|
7 | 17% | 14% | 6 | 16 | -6% | -9% | 17 | |||||||||||||||||
|
Total new software license revenues
|
$ | 971 | 14% | 9% | $ | 855 | $ | 1,534 | 11% | 7% | $ | 1,380 | |||||||||||||
|
% Revenues by Product:
|
|||||||||||||||||||||||||
|
Database technology
|
78% | 84% | 81% | 82% | |||||||||||||||||||||
|
Applications
|
22% | 16% | 19% | 18% | |||||||||||||||||||||
Fiscal Second Quarter 2005 Compared to Fiscal Second Quarter 2004: Excluding the effect of currency rate fluctuations, new software license revenues increased in the second quarter of fiscal 2005 primarily due to improved sales execution and increased demand for our software license products. Applications revenues contributed 68% to the growth in new software license revenues, while database technology revenues contributed 32%. All regions reported robust applications revenue growth rates. The high applications revenue growth rate this quarter was due in part to two large transactions totaling approximately $47.2 million. Database technology revenues had modest growth in all regions, except the Americas, primarily due to slightly negative revenue growth in the United States. The Americas contributed 34%, EMEA contributed 54% and Asia Pacific contributed 12% to the increase in new software license revenues.
23
New software license revenues earned from large transactions, defined as new software license transactions over $0.5 million, increased from 36% of new software license revenues in the second quarter of fiscal 2004 to 40% of new software license revenues in the second quarter of fiscal 2005. New software license revenues earned from large contracts increased by 24% from the second quarter of fiscal 2004. Excluding the two large applications transactions that were consummated during the quarter, new software license revenues from large contracts increased 9%.
Excluding the effect of foreign currency rate fluctuations, sales and marketing expenses increased slightly due to higher commission expenses that resulted from higher revenue levels, as well as higher salaries associated with increased sales headcount, partially offset by the release of a $23.0 million legal reserve as the result of a favorable judgment in an ongoing legal proceeding that became final during the quarter. Marketing expenses also declined as a result of lower headcount levels and marketing expenditures.
New software license margin increased as a result of higher new software license revenues.
First Half Fiscal 2005 Compared to First Half Fiscal 2004: Excluding the effect of currency rate fluctuations, the growth in new software license revenues in the first half of fiscal 2005 is primarily attributed to the same reasons noted above. On a year to date basis, database technology revenues contributed 75% to the growth in new software license revenues, while applications revenues contributed 25%. The Americas contributed 51%, EMEA contributed 15% and Asia Pacific contributed 34% to the increase in new software license revenues in the first half of fiscal 2005.
New software license revenues earned from large transactions were 35% of new software license revenues in both the first half of fiscal 2004 and fiscal 2005. New software license revenues earned from large contracts increased by 12% in the first half of fiscal 2005.
Excluding the effect of foreign currency rate fluctuations, sales and marketing expenses were essentially flat primarily due to the release of a $23.0 million legal reserve as the result of a favorable judgment in a legal proceeding that became final during the quarter. Excluding this adjustment, sales and marketing expenses increased due to higher commission expenses that resulted from higher revenue levels, as well as higher salaries associated with increased sales headcount, partially offset by lower marketing personnel expenditures.
New software license margin increased as a result of higher new software license revenues.
Software License Updates and Product Support: Software license updates grant customers rights to unspecified software product upgrades and maintenance releases issued during the support period. Product support includes internet access to technical content, as well as internet and telephone access to technical support personnel. The cost of providing support services consists largely of personnel related expenses.
| Three Months Ended November 30, | Six Months Ended November 30, | ||||||||||||||||||||||||||||||||
| Percent Change | Percent Change | ||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2004 | Actual | Constant | 2003 | 2004 | Actual | Constant | 2003 | |||||||||||||||||||||||||
| Software License Updates and Product Support Revenues: | |||||||||||||||||||||||||||||||||
|
Americas
|
$ | 633 | 6% | 6% | $ | 596 | $ | 1,240 | 8% | 8% | $ | 1,149 | |||||||||||||||||||||
|
EMEA
|
451 | 20% | 10% | 375 | 863 | 19% | 9% | 727 | |||||||||||||||||||||||||
|
Asia Pacific
|
168 | 17% | 13% | 143 | 324 | 19% | 14% | 272 | |||||||||||||||||||||||||
|
Total revenues
|
1,252 | 12% | 8% | 1,114 | 2,427 | 13% | 9% | 2,148 | |||||||||||||||||||||||||
|
Expenses
|
141 | -1% | -5% | 143 | 277 | 5% | 1% | 264 | |||||||||||||||||||||||||
|
Total Margin
|
$ | 1,111 | 14% | 10% | $ | 971 | $ | 2,150 | 14% | 10% | $ | 1,884 | |||||||||||||||||||||
|
Total Margin %
|
89% | 87% | 89% | 88% | |||||||||||||||||||||||||||||
|
% Revenues by Geography:
|
|||||||||||||||||||||||||||||||||
|
Americas
|
51% | 53% | 51% | 53% | |||||||||||||||||||||||||||||
|
EMEA
|
36% | 34% | 36% | 34% | |||||||||||||||||||||||||||||
|
Asia Pacific
|
13% | 13% | 13% | 13% | |||||||||||||||||||||||||||||
24
Fiscal Second Quarter 2005 Compared to Fiscal Second Quarter 2004: Software license updates and product support revenue growth rates are affected by the renewal rate of annual support contracts by existing customers, as well as the overall new software license revenue growth rates. The growth rate of software license updates and product support revenues does not necessarily correlate directly to the growth rate of new software license revenues. The increase in software license updates and product support revenues in the second quarter of fiscal 2005 is a result of the renewal of a substantial majority of the subscription base eligible for renewal in the current quarter, the addition of software license updates and product support revenues associated with new software license revenues recognized in the last twelve months, as well as more timely contract renewals. Excluding the effect of currency rate fluctuations, the Americas contributed 37% to the growth in software license updates and product support revenues, EMEA contributed 43% and Asia Pacific contributed 20%.
Excluding the effect of currency rate fluctuations, software license updates and product support expenses decreased in the second quarter of fiscal 2005 primarily due to lower discretionary bonuses. The software license updates and product support margin as a percent of revenues increased due to higher revenues and lower expenses.
First Half Fiscal 2005 Compared to First Half Fiscal 2004: The growth in software license updates and product support revenues in the first half of fiscal 2005 is attributed to the same reasons noted above. Excluding the effect of currency rate fluctuations, the Americas contributed 44% to the growth in software license updates and product support revenues, EMEA contributed 36% and Asia Pacific contributed 20%.
Excluding the effect of currency rate fluctuations, software license updates and product support expenses increased in the first half of fiscal 2005 primarily due to higher salary expenses associated with increased headcount, partially offset by lower discretionary bonuses. The software license updates and product support margin as a percent of revenues increased, as revenues grew at a higher rate than expenses.
Services Business
Our services business consists of consulting, advanced product services and education.
Consulting: Consulting revenues are earned by providing services to customers specializing in the design, implementation, deployment, upgrade and migration of our database technology and applications software. The cost of providing consulting services consists primarily of personnel related expenditures.
| Three Months Ended November 30, | Six Months Ended November 30, | ||||||||||||||||||||||||
| Percent Change | Percent Change | ||||||||||||||||||||||||
| (Dollars in millions) | 2004 | Actual | Constant | 2003 | 2004 | Actual | Constant | 2003 | |||||||||||||||||
|
Consulting Revenues:
|
|||||||||||||||||||||||||
|
Americas
|
$ | 194 | -11% | -11% | $ | 217 | $ | 388 | -12% | -12% | $ | 440 | |||||||||||||
|
EMEA
|
171 | 19% | 9% | 144 | 308 | 14% | 5% | 270 | |||||||||||||||||
|
Asia Pacific
|
30 | -14% | -18% | 35 | 55 | -33% | -37% | 82 | |||||||||||||||||
|
Total revenues
|
395 | 0% | -4% | 396 | 751 | -5% | -9% | 792 | |||||||||||||||||
|
Expenses
|
332 | -2% | -5% | 338 | 653 | -5% | -8% | 684 | |||||||||||||||||
|
Total Margin
|
$ | 63 | 9% | 4% | $ | 58 | $ | 98 | -9% | -11% | $ | 108 | |||||||||||||
|
Total Margin %
|
16% | 15% | 13% | 14% | |||||||||||||||||||||
|
% Revenues by Geography:
|
|||||||||||||||||||||||||
|
Americas
|
49% | 55% | 52% | 56% | |||||||||||||||||||||
|
EMEA
|
43% | 36% | 41% | 34% | |||||||||||||||||||||
|
Asia Pacific
|
8% | 9% | 7% | 10% | |||||||||||||||||||||
Fiscal Second Quarter 2005 Compared to Fiscal Second Quarter 2004: Consulting revenues tend to lag software revenues by several quarters since consulting services, if purchased, are typically performed after the
25
Excluding the effect of currency rate fluctuations, the decline in consulting expenses in the second quarter of fiscal 2005 is due primarily to a reduction of personnel related expenditures as a result of lower headcount and revenue levels, as well as the hiring of personnel in countries where personnel costs are lower than in the United States and certain European countries. The consulting margin as a percentage of revenues increased, as consulting expenses declined at a higher rate than consulting revenues.
First Half Fiscal 2005 Compared to First Half Fiscal 2004: Excluding the effect of currency rate fluctuations, the growth rates for both consulting revenues and expenses in the first half of fiscal 2005 were due to the same reasons noted above.
Advanced Product Services: Advanced product services are comprised of Oracle On Demand and advanced product support services. Oracle On Demand provides multi-featured software and hardware management and maintenance services for our database technology and applications software. Advanced product support services are earned by providing customers configuration and performance analysis, personalized support and annual on-site technical services. The cost of providing advanced product services consists primarily of personnel related expenditures and hardware and facilities costs for Oracle On Demand.
| Three Months Ended November 30, | Six Months Ended November 30, | ||||||||||||||||||||||||
| Percent Change | Percent Change | ||||||||||||||||||||||||
| (Dollars in millions) | 2004 | Actual | Constant | 2003 | 2004 | Actual | Constant | 2003 | |||||||||||||||||
|
Advanced Product Services
Revenues:
|
|||||||||||||||||||||||||
|
Americas
|
$ | 37 | 6% | 5% | $ | 35 | $ | 77 | 13% | 13% | $ | 68 | |||||||||||||
|
EMEA
|
24 | 9% | 1% | 22 | 45 | 10% | 1% | 41 | |||||||||||||||||
|
Asia Pacific
|
11 | 38% | 31% | 8 | 21 | 31% | 26% | 16 | |||||||||||||||||
|
Total revenues
|
72 | 11% | 7% | 65 | 143 | 14% | 10% | 125 | |||||||||||||||||
|
Expenses
|
58 | 0% | -5% | 58 | 111 | 5% | -1% | 106 | |||||||||||||||||
|
Total Margin
|
$ | 14 | 100% | 106% | $ | 7 | $ | 32 | 68% | 62% | $ | 19 | |||||||||||||
|
Total Margin %
|
19% | 11% | 22% | 15% | |||||||||||||||||||||
|
% Revenues by Geography:
|
|||||||||||||||||||||||||
|
Americas
|
52% | 54% | 54% | 54% | |||||||||||||||||||||
|
EMEA
|
33% | 34% | 31% | 33% | |||||||||||||||||||||
|
Asia Pacific
|
15% | 12% | 15% | 13% | |||||||||||||||||||||
Fiscal Second Quarter 2005 Compared to Fiscal Second Quarter 2004: Excluding the effect of currency rate fluctuations, advanced product services revenues increased in the second quarter of fiscal 2005 primarily due to the expansion of our subscription base in Oracle On Demand services. The Americas contributed 41% to the increase in advanced product services revenues, EMEA contributed 11% and Asia Pacific contributed 48%.
Excluding the effect of currency rate fluctuations, total advanced product services expenses decreased in the second quarter of fiscal 2005 primarily due to lower discretionary bonus expenses, partially offset by increased personnel expenditures. We have hired additional personnel to support current and future growth in our Oracle On Demand business. The advanced product services margin as a percent of revenues increased as revenues grew at a higher rate than Oracle On Demand expenses.
26
First Half Fiscal 2005 Compared to First Half Fiscal 2004: Excluding the effect of currency rate fluctuations, the growth rates for advanced product services revenues and expenses in the first half of fiscal 2005 were due to the same reasons noted above. The Americas contributed 70% to the increase in advanced product services revenues, EMEA contributed 7% and Asia Pacific contributed 23%.
Education: Education revenues are earned by providing instructor led, media based and internet based training in the use of our database technology and applications software. Education expenses primarily consist of personnel related expenditures, facilities and external contractor costs.
| Three Months Ended November 30, | Six Months Ended November 30, | ||||||||||||||||||||||||
| Percent Change | Percent Change | ||||||||||||||||||||||||
| (Dollars in millions) | 2004 | Actual | Constant | 2003 | 2004 | Actual | Constant | 2003 | |||||||||||||||||
|
Education Revenues:
|
|||||||||||||||||||||||||
|
Americas
|
$ | 23 | -8% | -8% | $ | 25 | $ | 42 | -13% | -13% | $ | 48 | |||||||||||||
|
EMEA
|
31 | 11% | 2% | 28 | 51 | 6% | -2% | 48 | |||||||||||||||||
|
Asia Pacific
|
12 | -20% | -23% | 15 | 23 | -21% | -24% | 29 | |||||||||||||||||
|
Total revenues
|
66 | -3% | -8% | 68 | 116 | -7% | -11% | 125 | |||||||||||||||||
|
Expenses
|
59 | 0% | -4% | 59 | 104 | -3% | -7% | 107 | |||||||||||||||||
|
Total Margin
|
$ | 7 | -22% | -28% | $ | 9 | $ | 12 | -33% | -37% | $ | 18 | |||||||||||||
|
Total Margin %
|
11% | 13% | 10% | 14% | |||||||||||||||||||||
|
% Revenues by Geography:
|
|||||||||||||||||||||||||
|
Americas
|
35% | 37% | 36% | 38% | |||||||||||||||||||||
|
EMEA
|
47% | 41% | 44% | 38% | |||||||||||||||||||||
|
Asia Pacific
|
18% | 22% | 20% | 24% | |||||||||||||||||||||
Fiscal Second Quarter 2005 Compared to Fiscal Second Quarter 2004: Excluding the effect of currency rate fluctuations, the decline in education revenues in the second quarter of fiscal 2005 is attributable to headcount reductions of information technology personnel across multiple industry sectors that have resulted in a continued reduction of the demand for technical product and end user application training. In addition, companies have delayed or limited technology training spending due to the discretionary nature of education services. The Americas contributed 33% to the decline in education revenues, EMEA contributed 15% and Asia Pacific contributed 52%.
Excluding the effect of currency rate fluctuations, education expenses decreased in the second quarter of fiscal 2005 due to reductions in personnel and related expenditures. The education margin as a percentage of revenues decreased as revenues declined at a higher rate than expenses.
First Half Fiscal 2005 Compared to First Half Fiscal 2004: Excluding the effect of currency rate fluctuations, the growth rates for education revenues and expense in the first half of fiscal 2005 were due to the same reasons noted above. The Americas contributed 41% to the decline in education revenues, EMEA contributed 13% and Asia Pacific contributed 46%.
Research and Development Expenses: Research and development expenses consist primarily of personnel related expenditures. We intend to continue to invest significantly in our research and development efforts because, in our judgment, they are essential to maintaining our competitive position.
| Three Months Ended November 30, | Six Months Ended November 30, | |||||||||||||||||||||||
| Percent Change | Percent Change | |||||||||||||||||||||||
| (Dollars in millions) | 2004 | Actual | Constant | 2003 | 2004 | Actual | Constant | 2003 | ||||||||||||||||
|
Expenses
|
$ | 327 | 1% | 0% | $ | 323 | $ | 639 | 3% | 2% | $ | 621 | ||||||||||||
|
Percent of Total Revenues
|
12% | 13% | 13% | 14% | ||||||||||||||||||||
Excluding the effect of foreign currency rate fluctuations, research and development expenses were essentially flat in the second quarter of fiscal 2005 as compared to the prior year corresponding period as a result of higher
27
General and Administrative Expenses: General and administrative expenses primarily consist of personnel related expenditures for information technology, finance, legal and human resources support functions.
| Three Months Ended November 30, | Six Months Ended November 30, | |||||||||||||||||||||||
| Percent Change | Percent Change | |||||||||||||||||||||||
| (Dollars in millions) | 2004 | Actual | Constant | 2003 | 2004 | Actual | Constant | 2003 | ||||||||||||||||
|
Expenses
|
$ | 153 | 12% | 8% | $ | 137 | $ | 307 | 15% | 11% | $ | 268 | ||||||||||||
|
Percent of Total Revenues
|
6% | 5% | 6% | 6% | ||||||||||||||||||||
Excluding the effect of foreign currency rate fluctuations, the increase in general and administrative expenses in the second quarter and first half of fiscal 2005 was primarily attributed to higher professional fees incurred in connection with the PeopleSoft tender offer. We incurred expenditures of $23.3 million and $13.8 million in the second quarter of fiscal 2005 and fiscal 2004 and $51.8 million and $28.4 million in the first half of fiscal 2005 and fiscal 2004 in connection with the PeopleSoft tender offer.
Other Income, Net: Other income, net consists primarily of interest income, interest expense, net foreign currency exchange gains (losses), net investment gains (losses) related to equity securities and the minority interest share in the net profits of Oracle Japan.
| Three Months Ended November 30, | Six Months Ended November 30, | ||||||||||||||||||||||||
| Percent Change | Percent Change | ||||||||||||||||||||||||
| (Dollars in millions) | 2004 | Actual | Constant | 2003 | 2004 | Actual | Constant | 2003 | |||||||||||||||||
|
Interest income
|
$ | 43 | 48% | 43% | $ | 29 | $ | 80 | 43% | 38% | $ | 56 | |||||||||||||
|
Interest expense
|
(6 | ) | 100% | 100% | (3 | ) | (11 | ) | -21% | -21% | (14 | ) | |||||||||||||
|
Net foreign currency losses
|
(7 | ) | 75% | 58% | (4 | ) | (11 | ) | 83% | 66% | (6 | ) | |||||||||||||
|
Minority interest
|
(10 | ) | -44% | -44% | (18 | ) | (19 | ) | -17% | -17% | (23 | ) | |||||||||||||
|
Net investment gains (losses) related to equity
securities
|
— | -100% | -100% | (4 | ) | 1 | -97% | -97% | 32 | ||||||||||||||||
|
Other
|
3 | 200% | 212% | 1 | 7 | 75% | 80% | 4 | |||||||||||||||||
|
Total other income, net
|
$ | 23 | * | * | $ | 1 | $ | 47 | -4% | -6% | $ | 49 | |||||||||||||
| * | not meaningful |
The increase in interest income is primarily due higher average cash balances and slightly higher interest rates available in the capital markets. In the second quarter and first half of fiscal 2005, the weighted average interest rate earned on cash, cash equivalents and investments increased from 1.5% to 1.9% and 1.5% to 1.7%. Interest expense in the first half of fiscal 2004 included $5.0 million in commitment fees related to our revolving credit facility obtained in connection with the PeopleSoft tender offer and additional interest associated with our $150 million senior notes that matured in February 2004. Net investment gains (losses) in fiscal 2004 primarily include a $35.4 million gain on the sale of our common stock in Liberate Technologies to a third-party for approximately $83.5 million.
Provision for Income Taxes: The effective tax rate in all periods is the result of the mix of income earned in various tax jurisdictions that apply a broad range of income tax rates. The provision for income taxes differs from the tax computed at the federal statutory income tax rate due primarily to state taxes and earnings considered as permanently reinvested in foreign operations. Future effective tax rates could be adversely
28
The effective tax rate was 29.4% and 30.0% for the second quarter and first half of fiscal 2005 as compared to 32.6% and 33.1% for the corresponding prior year periods. The effective tax rate for the first half of fiscal 2005 on operating and other income was reduced to 30.0% in the second quarter from 31.0% in the first quarter. The decrease in the effective tax rate is attributable to higher earnings in low tax rate jurisdictions combined with a weakening dollar in those same jurisdictions. In fiscal 2004, the effective tax rate was a blend of the effective tax rate on operating and other income, increased by the tax rate on the gain from the sale of our investment in Liberate Technologies in the first quarter. The effective tax rate for the first half of fiscal 2004 on operating and other income was reduced to 33.0% in the second quarter from 33.5% in the first quarter.
On October 22, 2004, the President of the United States signed into law the American Jobs Creation Act of 2004 replacing the ETI tax incentive with a deduction for production. In the long term we expect this new deduction to provide a similar tax benefit as the ETI tax incentive has in the past. We may have a small reduction in our fiscal year 2005 tax benefit as the transition rules create a short-term gap in the benefit we receive.
On December 12, 2004, we entered into an Agreement and Plan of Merger with PeopleSoft. Costs incurred with our tender offer for PeopleSoft prior to the date of this agreement have been expensed in our consolidated statements of operations. At November 30, 2004, we had deferred tax assets associated with these costs of approximately $44 million. As we now expect the merger to be completed, these costs will no longer be deductible for tax purposes, and therefore, we expect these costs will increase our income tax expense in the third quarter of fiscal 2005.
Liquidity and Capital Resources
| November 30, | May 31, | |||||||||||
| (Dollars in millions) | 2004 | Change | 2004 | |||||||||
|
Working capital
|
$ | 7,589 | 7% | $ | 7,064 | |||||||
|
Cash, cash equivalents and short-term investments
|
$ | 9,436 | 10% | $ | 8,587 | |||||||
Cash, cash equivalents and short-term investments: Cash and cash equivalents consist of highly liquid investments in time deposits held at major banks, commercial paper, United States government agency discount notes, money market mutual funds and other money market securities with original maturities of 90 days or less. Short-term investments include all investments with original maturities of greater than 90 days that mature in the next twelve months.
| Six Months Ended November 30, | ||||||||||||
| (Dollars in millions) | 2004 | Change | 2003 | |||||||||
|
Cash provided by operating activities
|
$ | 1,799 | 12% | $ | 1,608 | |||||||
|
Cash provided by (used for) investing activities
|
$ | 818 | 142% | $ | (1,966 | ) | ||||||
|
Cash used for financing activities
|
$ | (956 | ) | 292% | $ | (244 | ) | |||||
Cash provided by operating activities: Our largest source of operating cash flows is cash collections from our customers following the purchase and renewal of their software license updates and product support agreements. Payments from customers for software license updates and product support are generally received by the beginning of the contract term, which is generally one year in length. Additionally, we generate significant cash from new software license sales, and to a lesser extent, services. Our primary uses of cash from operating activities are for personnel related expenditures, payment of taxes, facilities and technology costs.
Cash flows from operating activities increased in the first half of fiscal 2005, primarily due to improved collections on higher revenue volumes in the fourth quarter of fiscal 2004 and first quarter of fiscal 2005 as compared to the corresponding prior year periods. Days sales outstanding, which is calculated by dividing period end accounts receivable by average daily sales for the quarter, was 50 at November 30, 2004 compared to 59 at May 31, 2004. The decline in days sales outstanding is due to more timely collections, as well as a shift
29
Operating cash flow was negatively impacted by a decrease in accounts payable and other liabilities from May 31, 2004. This decrease is a result of larger commission and value-added tax payments made during the first half of fiscal 2005 as compared to the prior year corresponding period, as a result of higher revenues in the fourth quarter of fiscal 2004.
Cash provided by (used for) investing activities: The changes in cash flows from investing activities primarily relate to the timing of purchases and maturities of investments. We also use cash to invest in capital and other assets to support our growth.
Cash provided by investing activities increased in the first half of fiscal 2005 due to higher proceeds from sales of investments, which more than offset purchases of investments. In the prior year corresponding period, purchases of investments were greater than proceeds from sales of investments.
Cash used for financing activities: We incurred negative cash flows from financing activities in the first half of fiscal 2005 and 2004, primarily as a result of common stock repurchases. Cash flow from operations and existing cash balances were used to repurchase our common stock. We repurchased 93.9 million shares for $1,094.8 million in the first half of fiscal 2005 compared to 33.3 million shares for $399.4 million in the first half of fiscal 2004. Large acquisitions may potentially reduce future share repurchases from historical levels.
Free cash flow: We believe reporting free cash flow provides more visibility to our ability to generate cash. We believe that this measure is also useful to investors as one of the bases for comparing our operating performance with our competitors. We evaluate free cash flow over a trailing twelve month period versus on a quarterly basis, as we manage our business on an annual basis. Free cash flow is not a measure of financial performance under U.S. generally accepted accounting principles and should not be considered in isolation or as an alternative to net income as an indicator of our performance, or as an alternative to cash flows from operating activities as a measure of liquidity. We calculate free cash flows as follows:
| Trailing Twelve Months Ended November 30, | |||||||||||||
| (Dollars in millions) | 2004 | Change | 2003 | ||||||||||
|
Cash provided by operating activities
|
$ | 3,386 | $ | 3,172 | |||||||||
|
Capital expenditures(1)
|
(178 | ) | (319 | ) | |||||||||
|
Free cash flow
|
$ | 3,208 | 12% | $ | 2,853 | ||||||||
|
Net income
|
$ | 2,948 | $ | 2,486 | |||||||||
|
Free cash flow as a percent of net income
|
109% | 115% | |||||||||||
| (1) | Represents capital expenditures as reported in cash flows from investing activities of our consolidated statements of cash flow presented in accordance with U.S. generally accepted accounting principles. |
Long-Term Customer Financing
We offer our customers the option to acquire our software and services through separate long-term payment contracts. We generally sell such contracts on a non-recourse basis to financial institutions. We record the transfers of amounts due from customers to financial institutions as sales of financial assets because we are considered to have surrendered control of these financial assets. For the six months ended November 30, 2004 and 2003, $163.1 million and $121.1 million or approximately 11% and 9% of our new software license revenues were financed through our financing division.
30
Contractual Obligations
The following is a summary of our contractual obligations as of November 30, 2004:
| Year Ending May 31, | |||||||||||||||||||||||||||||||||
| (in millions) | Total | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 | Thereafter | |||||||||||||||||||||||||
|
Balance Sheet Contractual
Obligations
|
|||||||||||||||||||||||||||||||||
|
Principal payments on senior notes
|
$ | 150 | $ | – | $ | – | $ | 150 | $ | – | $ | – | $ | – | $ | – | |||||||||||||||||
|
Notes payable
|
15 | 9 | – | 6 | – | – | – | – | |||||||||||||||||||||||||
|
Long-term deferred tax liabilities(1)
|
17 | ||||||||||||||||||||||||||||||||
|
Total contractual obligations
|
182 | 9 | – | 156 | – | – | – | – | |||||||||||||||||||||||||
|
Other Contractual Obligations
|
|||||||||||||||||||||||||||||||||
|
Interest payments on senior notes(2)
|
14 | 3 | 6 | 5 | – | – | – | – | |||||||||||||||||||||||||
|
Operating leases
|
552 | 67 | 113 | 89 | 65 | 53 | 40 | 125 | |||||||||||||||||||||||||
|
Purchase obligations(3)
|
5 | 4 | 1 | – | – | – | – | – | |||||||||||||||||||||||||
|
Funding commitments(1)(4)
|
12 | ||||||||||||||||||||||||||||||||
|
Total other contractual obligations
|
583 | 74 | 120 | 94 | 65 | 53 | 40 | 125 | |||||||||||||||||||||||||
|
Total contractual obligations
|
$ | 765 | $ | 83 | $ | 120 | $ | 250 | $ | 65 | $ | 53 | $ | 40 | $ | 125 | |||||||||||||||||
| (1) | The timing of future cash outflows related to these obligations is not known. |
| (2) | Represents estimated interest payments on our senior notes using an effective interest rate of 4.10% at November 30, 2004. We entered into an interest-rate swap agreement that has the economic effect of modifying the interest obligations associated with our 6.91% senior notes so that the interest payable on the senior notes effectively becomes variable. |
| (3) | Represents amounts associated with agreements that are enforceable, legally binding and specify terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the payment. |
| (4) | Funding commitments relate to the maximum additional capital we may need to contribute toward our venture fund investments which are payable upon demand. |
Tender Offer for PeopleSoft, Inc.
On June 9, 2003, we commenced an unsolicited tender offer for all of the outstanding shares of common stock of PeopleSoft, Inc., a Delaware corporation. We have since amended and extended the offer on numerous occasions.
On December 12, 2004, we and our acquisition subsidiary entered into an Agreement and Plan of Merger with PeopleSoft, increased our offer price to $26.50 per share and amended the expiration date of our offer to December 28, 2004. We expect that we will need approximately $10.3 billion to purchase all shares that we estimate will be outstanding prior to the expiration of the offer and to pay estimated fees and expenses. The offer will be extended if less than a majority of the total number of shares of PeopleSoft common stock outstanding on a fully diluted basis have been tendered and not withdrawn at the expiration date. Following the conclusion of the offer, the remaining holders of issued and outstanding shares of PeopleSoft common stock will receive $26.50 per share and our acquisition subsidiary will be merged with and into PeopleSoft. In addition, options to acquire shares of PeopleSoft that are outstanding prior to the consummation of the merger will be converted into options to acquire shares of Oracle common stock based on a formula provided in the merger agreement.
On December 24, 2003, we entered into a 364-Day Revolving Credit Facility (the Credit Facility) with Credit Suisse First Boston (an affiliate of Credit Suisse First Boston LLC) and certain other syndicated lenders named in the Credit Facility. The Credit Facility provides an unsecured revolving credit facility to us or an
31
From the inception of our tender offer for PeopleSoft in June 2003 to November 30, 2004, we have incurred approximately $111.5 million of expenditures. We have incurred expenditures of $23.3 million and $51.8 million for the three and six months ended November 30, 2004 and $13.8 million and $28.4 million for the three and six months ended November 30, 2003. These costs are included in general and administrative expense in the condensed consolidated statements of operations. We also incurred $5.0 million of commitment fees for the Credit Facility, which is included in other income, net in the condensed consolidated statements of operations in the six months ended November 30, 2003. We will continue to incur costs in connection with our tender offer for PeopleSoft.
We believe that our current cash and cash equivalents, short-term investments and cash generated from operations will be sufficient to meet our working capital, capital expenditure, contractual obligations and investment needs. We will need up to approximately $10.3 billion to purchase all shares that we estimate will be outstanding prior to the expiration date of the PeopleSoft tender offer and to pay estimated fees and expenses related to the offer. We expect, based upon the combination of internally available cash and investments as of November 30, 2004, additional cash generated since that date, borrowings under the Credit Facility or any other credit facility or the issuance of securities, to have sufficient cash on hand at the expiration of the offer to pay the offer price for all shares in the offer. The offer is not conditioned upon any financing arrangements. In addition, we believe we could fund other acquisitions with our internally available cash and investments, cash generated from operations, additional credit facilities or from the issuance of additional securities.
Stock Options
Our stock option program is a key component of the compensation package we provide to attract and retain talented employees and align their interests with the interests of existing stockholders. We recognize that options dilute existing stockholders and have sought to control the number of options granted while providing competitive compensation packages. Consistent with these dual goals, our cumulative potential dilution over the last three full fiscal years has been less than 1.0%, and has averaged 0.7% per year. The potential dilution percentage is calculated as the new option grants for the year, net of options forfeited by employees leaving the company, divided by the total outstanding shares at the beginning of the year. This maximum potential dilution will only result if all options are exercised. Many of these options, which have 10-year exercise periods, have exercise prices substantially higher than the current market price. At November 30, 2004, 21.4% of our outstanding stock options had exercise prices in excess of the current market price. Consistent with our historic practices, we do not expect that dilution from future grants before the effect of our stock repurchase program will exceed 1.5% per year for our ongoing business. Over the last 10 years, our stock repurchase program has more than offset the dilutive effect of our stock option program. At November 30, 2004, the maximum potential dilution from all outstanding and unexercised option awards, regardless of when granted and regardless of whether vested or unvested and including options where the strike price is higher than the current market price, was 8.9%.
The Committee on Compensation and Management Development of the Board of Directors reviews and approves the organization-wide stock option grants to selected employees, all stock option grants to executive officers and any individual stock option grant in excess of 25,000 shares. A separate Plan Committee, which is an executive officer committee, approves individual stock option grants up to 25,000 shares to non-executive officers and employees.
32
Option information from June 1, 2001 through November 30, 2004 is summarized as follows:
| (Shares | |||||
| in millions) | |||||
|
Options outstanding at May 31, 2001
|
442 | ||||
|
Options granted
|
213 | ||||
|
Options exercised
|
(132 | ) | |||
|
Cancellations
|
(70 | ) | |||
|
Options outstanding at November 30, 2004
|
453 | ||||
|
Average annualized options granted, net of
cancellations
|
41 | ||||
|
Average annualized stock repurchases
|
198 | ||||
|
Shares outstanding at November 30, 2004
|
5,104 | ||||
|
Weighted average shares outstanding from
June 1, 2001 through November 30, 2004
|
5,316 | ||||
|
Options outstanding as a percent of shares
outstanding at November 30, 2004
|
8.9% | ||||
|
In the money options outstanding (based on our
November 30, 2004 stock price) as a percent of shares
outstanding at November 30, 2004
|
7.0% | ||||
|
Average annualized options granted, net of
cancellations and before stock repurchases, as a percent of
weighted average shares outstanding from June 1, 2001
through November 30, 2004
|
0.8% | ||||
|
Average annualized options granted, net of
cancellations and after stock repurchases, as a percent of
average shares outstanding from June 1, 2001 through
November 30, 2004
|
-3.0% | ||||
Generally, we grant stock options to our existing employees on an annual basis. During the six months ended November 30, 2004, we made our annual grant of options and other grants to purchase approximately 38.3 million shares of our stock, which was partially offset by 8.1 million shares for canceled options. On December 16, 2004, the FASB issued Statement No. 123 (revised 2004), Share-Based Payment, which will require us to measure all employee stock-based compensation awards using a fair value method and record such expense in our consolidated financial statements. Statement 123(R) is effective beginning in our second quarter of fiscal 2006. The adoption of Statement 123(R) could have a material impact on our consolidated financial position, results of operations, and cash flows.
New Accounting Pronouncements
The material set forth in Note 11 of Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q is incorporated herein by reference.
Factors That May Affect Our Future Results or the Market Price of Our Stock
We operate in a rapidly changing economic and technological environment that presents numerous risks. Many of these risks are beyond our control and are driven by factors that we cannot predict. The following discussion, as well as our discussion above of critical accounting policies and estimates, highlights some of these risks.
Economic, political and market conditions can adversely affect our revenue growth. Our revenue growth and profitability depend on the overall demand for computer software and services, particularly in the sectors in which we offer products. Because our sales are primarily to corporate and government customers, the health of our business is directly related to the strength of general economic and business conditions. While the global economic environment continues to improve, such recovery has been modest and uneven. A general weakening of the global economy and weakening of business conditions, particularly in the high technology, telecommunications, financial services and manufacturing industry sectors, as well as the imposition of governmental budgetary constraints, could result in delays and decreases of customer purchases. In addition to sales of new software licenses, we derive a significant proportion of our revenues from new purchases and recurring renewals of software license updates and product support. A general weakening of the global
33
Although our business depends materially on the condition of domestic and foreign economies, and on the performance of key industry sectors that generate a disproportionate percentage of our revenues and earnings, our management has no comparative advantage in forecasting macroeconomic trends and developments relating to these general business conditions. Our management is, however, required to make forecasts in order to develop budgets, plan research and development strategies and perform a wide variety of general management functions. To the extent that our forecasts are in error, because we are either overly optimistic or overly pessimistic about the performance of an economy or of an industry sector, our performance could suffer because of a failure to properly match corporate strategy with economic conditions.
There are specific risks associated with our proposed acquisition of PeopleSoft. In June 2003, we commenced an unsolicited cash tender offer for all of the outstanding shares of common stock of PeopleSoft. On December 12, 2004, we and our acquisition subsidiary entered into an Agreement and Plan of Merger with PeopleSoft, pursuant to which, subject to satisfaction or waiver of certain conditions, our subsidiary will merge with and into PeopleSoft. In addition to the risks we face in connection with acquisitions generally, there are several unique risks we face in connection with the PeopleSoft offer including:
| • | we have little experience integrating and managing a multi-billion dollar acquisition; | |
| • | we may have higher than anticipated costs in continuing support and development of acquired PeopleSoft products; | |
| • | we may not realize the anticipated increase in our revenues if a larger than predicted number of PeopleSoft customers decline to renew software license updates and product support; | |
| • | PeopleSoft implemented several defensive tactics, including providing customers negotiating new contracts a refund program that may require an acquiror, including us, to pay those customers two to five times their license fees if certain business events (such as the termination of support for PeopleSoft products) occur during a fixed period of time. Based on public statements by PeopleSoft, we anticipate that this program could result in more than $2.43 billion in potential refund liabilities if triggered; | |
| • | in connection with the tender offer, we have also been named as a defendant in various legal proceedings and we may be a party to additional legal proceedings in the future. Pursuant to the merger agreement, we and PeopleSoft have agreed to stay all litigation between the parties and, at such time as Oracle acquires control of PeopleSoft’s board, each party will dismiss with prejudice all such litigation and release all claims against the other parties to the merger agreement. If the merger agreement is terminated, such litigation may be resumed and additional proceedings could be commenced against any party to the merger agreement. These proceedings could result in substantial costs and could divert management’s attention and other corporate resources; | |
| • | our offer is not conditioned on any financing arrangements. We plan to pay for the PeopleSoft shares and related transaction fees and expenses with internally available cash and borrowings. We may not be able to arrange favorable financing terms. Depending upon the final financial structure of the transaction, our credit rating may be reduced, which may increase the cost of future borrowings; and | |
| • | beyond reviewing publicly available information and certain information that PeopleSoft has recently furnished to us, we have not been able to conduct any due diligence on PeopleSoft and there may be liabilities or accounting or internal control issues of which we are not aware. |
34
While we intend to proceed with our offer, we cannot assure you that we will be successful in acquiring or integrating PeopleSoft.
Our success depends upon our ability to develop new products and services and enhance our existing products and services. Rapid technological advances in hardware and software development, evolving standards in computer hardware, software technology and communications infrastructure, changing customer needs and frequent new product introductions and enhancements characterize the enterprise software market in which we compete. To keep pace with technological developments, satisfy increasingly sophisticated customer requirements and achieve market acceptance, we must enhance and improve existing products and services like Oracle Database, Oracle Application Server, Oracle E-Business Suite, Oracle Collaboration Suite, Oracle Customer Data Hub and Oracle On Demand and we must also continue to introduce new products and services. If we are unable to develop new products or adapt our current products to run on new or popular operating systems, if we are unable to enhance and improve our products successfully in a timely manner, or if we fail to position and/or price our products to meet market demand, customers may not buy new software licenses and our business and operating results will be adversely affected. If our enhancements to existing products do not deliver the functionality that our customer base demands, our customers may not renew software license updates and product support and our business and operating results will be adversely affected. In addition, standards for network protocols, as well as other industry adopted and de facto standards for the internet, are rapidly evolving. We cannot provide any assurance that the standards on which we choose to develop new products will allow us to compete effectively for business opportunities as they arise in emerging areas. Accelerated product introductions and short product life cycles require high levels of expenditures for research and development that could adversely affect our operating results. Further, any new products we develop may not be introduced in a timely manner and may not achieve the broad market acceptance necessary to generate significant revenues. Finally, while customers make first-time buying decisions based on the products, many make future license and support buying decisions based upon the quality of the support offering. If we do not continue to enhance our support services our renewal rates for product support may decline, which could affect our operating results.
Our sales forecasts may not consistently correlate to revenues in a particular quarter. We use a “pipeline” system, a common industry practice, to forecast sales and trends in our business. Our sales personnel monitor the status of all proposals, such as the date when they estimate that a customer will make a purchase decision and the potential dollar amount of the sale. These estimates are aggregated periodically to generate a sales pipeline. We compare this pipeline at various points in time to evaluate trends in our business. This analysis provides some guidance in business planning and budgeting, but these pipeline estimates are by their nature speculative. Our pipeline estimates are not necessarily reliable predictors of revenues in a particular quarter or over a longer period of time, partially because of changes in conversion rates of the pipeline into contracts that can be very difficult to estimate. A variation in the conversion rate of the pipeline into contracts, or in the pipeline itself, could cause us to plan or budget incorrectly and thereby adversely affect our business or results of operations. In particular, a slowdown in information technology spending or economic conditions can cause purchasing decisions to be delayed, reduced in amount or cancelled, which would reduce the overall software license pipeline conversion rate in a particular period of time. Because a substantial portion of our software license revenue contracts are completed in the latter part of a quarter, we may not be able to adjust our cost structure promptly in response to a decrease in our pipeline conversion rate.
Our quarterly revenues and operating results can be difficult to predict and can fluctuate substantially. Our revenues in general, and our new software license revenues in particular, are difficult to forecast and are likely to fluctuate substantially from quarter to quarter due to a number of factors, many of which are outside of our control. These factors include:
| • | the relatively long sales cycles for many of our products; | |
| • | the tendency of some of our customers to wait until the end of a fiscal quarter or our fiscal year in the hope of obtaining more favorable terms; | |
| • | the timing of our or our competitors’ new products or product enhancements or any delays in such introductions; |
35
| • | delays or deferrals of customer implementations of our products; | |
| • | changes in customer budgets that could affect both the timing and size of any transaction; | |
| • | delays in recognizing revenue on any transaction; | |
| • | changes in the renewal rate for software license updates and product support contracts; | |
| • | seasonality of technology purchases; | |
| • | changes in local, national and international regulatory requirements; | |
| • | changes in general economic, political or market conditions; | |
| • | changes in exchange rates; | |
| • | changes in the product selection purchasing patterns of our customers between standard edition products and higher premium products; and | |
| • | changes in our pricing policies or the policies of our competitors. |
Our new software license revenues in any quarter depend on orders booked and delivered in that particular quarter. Our software license updates and product support revenues, which are recognized ratably over the support term, are impacted by the renewal rate of annual support contracts by existing customers, as well as customers purchasing software license updates and product support in connection with purchasing new software licenses. Our operating expenses are budgeted based on our estimates of revenues and a high percentage of our expenses are fixed. Accordingly, our quarterly results are difficult to predict with any accuracy until the very end of a quarter. If even a small number of large software license transactions are delayed until after a quarter ends, our operating results and our net income for the quarter could fall significantly short of our predictions.
Our international sales and operations subject us to additional risks that can adversely affect our operating results. We derive a substantial portion of our revenues from customers outside the United States. We have significant operations outside of the United States, including software development, sales, customer support and shared administrative service centers, and we plan to expand our international operations, including continued expansion in China and India. Our international operations are subject to a variety of risks, including:
| • | general economic conditions in each country or region; | |
| • | the overlap of different tax regimes; | |
| • | fluctuations in currency exchange rates and difficulties in transferring funds from certain countries; | |
| • | the difficulty of managing an organization operating in various countries; | |
| • | growing political sentiment against international outsourcing of support services and development; | |
| • | changes in regulatory requirements; | |
| • | compliance with a variety of international laws and regulations, including trade restrictions, local labor ordinances and changes in tariff rates; | |
| • | longer payment cycles and difficulties in collecting accounts receivable; | |
| • | import and export licensing requirements; | |
| • | political unrest, terrorism and the potential for other hostilities, particularly in areas in which we have facilities; and | |
| • | reduced protection for intellectual property rights in some countries. |
Our success depends, in part, on our ability to anticipate and address these risks. We cannot guarantee that these or other factors will not adversely affect our business or operating results.
36
We conduct a significant portion of our business in currencies other than the United States Dollar. We have no comparative advantage in forecasting these rates. Our operating results are therefore subject to fluctuations in foreign currency exchange rates. Our revenues and operating results are adversely affected when the United States Dollar strengthens relative to other currencies and are positively affected when the United States Dollar weakens. Changes in the value of major foreign currencies, particularly the Euro, Japanese Yen and British Pound relative to the value of the United States Dollar positively affected revenues and operating results in fiscal 2004 and the first half of fiscal 2005. If the United States Dollar strengthens throughout the remainder of fiscal 2005 relative to other currencies, our revenues and operating results will be adversely affected. Our foreign currency transaction gains and losses are primarily related to sublicense fees and other agreements among our subsidiaries, our distributors and ourselves. These gains and losses are charged against earnings in the period incurred. To reduce our transaction and translation gains and losses associated with converting foreign currencies into United States Dollars, we enter into foreign exchange forward contracts to hedge certain transaction and translation exposures in major currencies. In certain instances, we do not hedge foreign currencies, such as when the forward contracts in the relevant currency are not readily available or are not, in our opinion, cost effective. As a result, we will continue to experience foreign currency gains and losses.
Acquisitions present many risks, and we may not realize the financial and strategic goals that were contemplated at the time of any transaction. We have in the past and expect in the future to acquire complementary companies, products, services and technologies. The risks we may encounter in acquisitions include:
| • | we may find that the acquired company or assets do not further our business strategy or that we paid more than what the company or assets are worth; | |
| • | we may have difficulty integrating the operations and personnel of the acquired businesses; | |
| • | we may have difficulty incorporating the acquired technologies or products with our existing product lines; | |
| • | we may have product liability, customer liability or intellectual property liability associated with the sale of the acquired company’s products; | |
| • | our ongoing business may be disrupted by transition or integration issues; | |
| • | our management’s attention may be diverted from other business concerns; | |
| • | our management may not be able to improve our financial and strategic position; | |
| • | we may be unable to obtain timely approvals from governmental authorities under applicable competition and antitrust laws; | |
| • | we may have difficulty maintaining uniform standards, controls, procedures and policies; | |
| • | our relationship with current and new employees, customers and distributors could be impaired; | |
| • | the acquisition may result in litigation from terminated employees or third parties; and | |
| • | our due diligence process may fail to identify significant issues with the target’s product quality, financial disclosures and accounting practices, internal control deficiencies, including material weaknesses, product architecture and legal contingencies, among other matters. |
These factors could have a material adverse effect on our business, results of operations, financial condition or cash flows, particularly in the case of a larger acquisition or number of acquisitions.
We previously have generally paid for acquisitions in cash. We may in the future pay for acquisitions in whole or in part with stock, other equity-related purchase rights or debt. To the extent that we issue shares of stock or other rights to purchase stock, including options, existing stockholders may be diluted and earnings per share may decrease.
We may need to change our pricing models to compete successfully. The intensely competitive markets in which we compete can put pressure on us to reduce our prices. If our competitors offer deep discounts on
37
We periodically have restructured our sales force, which can be disruptive. We continue to rely heavily on our direct sales force. In many years, we have restructured or made other adjustments to our sales force in response to factors such as management changes, product changes, performance issues and other internal considerations. We recently made some adjustments to the organization of our sales force to consolidate our Government, Education and Healthcare organizations into our North America Sales and Consulting organization, to focus our Latin America and Asia Pacific (excluding Japan) sales force separately on our database management software or applications software products and to simplify our coverage model. We are also currently in the process of separating our EMEA sales force between database management software and applications software. In the past, changes in the structure of the sales force and sales force management have generally resulted in a temporary lack of focus and reduced productivity that may have affected revenues in one or more quarters. We cannot assure you that we will not continue to restructure our sales force or that the transition issues associated with restructuring the sales force will not recur.
Disruptions of our indirect sales channel could affect our future operating results. In addition to marketing our products and services through our own direct sales and service forces, we market our products and services through indirect channels. Our indirect channel network is comprised primarily of resellers, system integrators/implementers, consultants, education providers, internet service providers, network integrators, and independent software vendors. We believe that our relationships with these channel participants enhance our marketing and sales efforts. Our financial results could be adversely affected if our contracts with channel participants were terminated, if our relationship with channel participants were to deteriorate, if any of our competitors enter into strategic relationships or acquire a significant channel participant, or if the financial condition of our channel participants were to weaken. In connection with our efforts to further penetrate markets, we will need to maintain or expand our relationships with indirect channel participants and develop additional relationships. There can be no assurance that we will be successful in maintaining, expanding or developing our relationships with these channel participants. If we are not successful, we may lose sales opportunities, customers and market share.
To be successful we must effectively compete in a range of markets within the highly competitive software industry. The software industry is intensely competitive. Many vendors develop and market databases, internet application server products, application development tools, business applications, collaboration products and business intelligence products that compete with our offerings. In addition, several companies offer business outsourcing as a competitive alternative to buying software. Some of these competitors have greater financial or technical resources than we do. We expect to continue to face intense competition in each market in which we compete. We could lose market share if our competitors introduce new competitive products into one or more of our markets, add new functionality into an existing competitive product, acquire a
38
If we cannot hire enough qualified employees or if we lose key employees, it will adversely affect our ability to manage our business, develop our products and increase our revenues. We believe our continued success depends to a large extent on the continued service of our senior management and other key employees and the hiring of new qualified employees. In the software industry, there is substantial and continuous competition for highly skilled business, product development, technical and other personnel. We may experience increased compensation costs that are not offset by either improved productivity or higher prices. We may not be successful in recruiting new personnel and in retaining and motivating existing personnel. Members of our senior management team have left Oracle over the years for a variety of reasons and we cannot assure you that there will not be additional departures. Any changes in management can be disruptive to our operations. With rare exceptions, we do not have long-term employment or non-competition agreements with our employees. Part of our total compensation program includes stock options. The volatility or lack of positive performance of our stock price may from time to time adversely affect our ability to retain or attract key employees. In addition, if we elected to or are required to treat all stock-based compensation as an expense, we may change both our cash and stock-based compensation practices. Some of the changes we are considering include the reduction in the number of employees granted options, a reduction in the number of options granted, the elimination or reduction of benefits under the employee stock purchase plan and a change to alternative forms of stock-based compensation. Any changes in our compensation practices or changes made by competitors could affect our ability to retain and motivate existing personnel and recruit new personnel.
If we account for employee stock option and employee stock purchase plans using the fair value method, it could significantly reduce our net income and earnings per share. There has been ongoing public debate whether employee stock option and employee stock purchase plans shares should be treated as a compensation expense and, if so, how to properly value such charges. If we elected or were required to record an expense for our stock-based compensation plans using a fair value method, we could have significant accounting charges. For example, in the first half of fiscal 2005, had we accounted for stock-based compensation plans using a fair value method prescribed under FASB Statement No. 123, as amended by Statement 148, net income would have been reduced by $78.5 million. On December 16, 2004, the FASB issued Statement No. 123 (revised 2004), Share-Based Payment, which will require us to measure all employee stock-based compensation awards using a fair value method and record such expense in our consolidated financial statements. Statement 123(R) is effective beginning in our second quarter of fiscal 2006. The adoption of Statement 123(R) could have a material impact on our consolidated financial position, results of operations and cash flows.
We might experience significant errors or security flaws in our products. Despite testing prior to release of the products, software products frequently contain errors or security flaws, especially when first introduced or when new versions are released. Software errors in our products could affect the ability of our products to work with other hardware or software products, could delay the development or release of new products or new versions of products and could adversely affect market acceptance of our products. Security flaws in our products could expose us to claims as well as harm our reputation, which could impact our future sales. The detection and correction of any security flaws can be time consuming and costly. In addition, we run our own business operations as well as Oracle On Demand on our products and any security flaws, if exploited, could affect our ability to conduct business operations. End users, who rely on our products for applications that are critical to their businesses, may have a greater sensitivity to product errors and security vulnerabilities than customers for software products generally. If we experience errors or delays in releasing new products or new
39
Some of our products are not as profitable as others. Some of our products require a higher level of development, distribution and support expenditures, on a percentage of revenues basis. If revenues generated from these products become a greater percentage of our total revenues and if the expenses associated with these products on a percentage of revenues basis do not decrease, then our operating margins will be adversely affected.
We may not receive significant revenues from our current research and development efforts for several years, if at all. Developing and localizing software is expensive and the investment in product development often involves a long payback cycle. In the first half of fiscal 2005, our research and development expenses were $639.2 million, or 13% of our total revenues. Our plans for the remainder of fiscal 2005 include significant investments in software research and development and related product opportunities. We believe that we must continue to dedicate a significant amount of resources to our research and development efforts to maintain our competitive position. However, we do not expect to receive significant revenues from these investments for several years.
We may not be able to protect our intellectual property. We rely on a combination of copyright, patent, trademark, trade secrets, confidentiality procedures and contractual commitments to protect our proprietary information. Despite our efforts, these measures can only provide limited protection. Unauthorized third parties may try to copy or reverse engineer portions of our products or otherwise obtain and use our intellectual property. Any patents owned by us may be invalidated, circumvented or challenged. Any of our pending or future patent applications, whether or not being currently challenged, may not be issued with the scope of the claims we seek, if at all. In addition, the laws of some countries do not provide the same level of protection of our proprietary rights as do the laws of the United States. If we cannot protect our proprietary technology against unauthorized copying or use, we may not remain competitive.
Third parties may claim we infringe their intellectual property rights. We sometimes receive notices from others claiming we are infringing their patent or other intellectual property rights. We expect the number of such claims will increase as the number of products and competitors in our industry segments grows and the functionality of products overlaps. Companies are more frequently seeking to patent software and business methods because of developments in the law that may extend the ability to obtain such patents. As a result, we expect to receive more patent infringement claims. Responding to any infringement claim, regardless of its validity, could:
| • | be time-consuming to defend; | |
| • | result in costly litigation; | |
| • | divert management’s time and attention from developing our business; | |
| • | require us to enter into royalty and licensing agreements that we would not normally find acceptable; | |
| • | require us to stop selling or to redesign our products; | |
| • | require us to pay money as damages; or | |
| • | require us to satisfy indemnification obligations that we have with our customers. |
If a successful claim is made against us and we fail to develop or license a substitute technology, our business, results of operations, financial condition or cash flows could be materially adversely affected.
Our sales to government clients subject us to risks including early termination, audits and investigations that can adversely affect our business. We derive a substantial portion of our revenues from contracts with the United States government and its agencies and from contracts with state and local governments and their agencies. Governments and their agencies may terminate most of these contracts at any time, without cause.
Also, there is increased pressure for all governments and their agencies, both domestically and internationally, to reduce spending. Our federal government contracts are subject to the approval of appropriations being made
40
Oracle On Demand may not be successful. We offer outsourcing services for our products through our three core offerings; Oracle E-Business Suite On Demand, Oracle Collaboration Suite On Demand and Oracle Technology On Demand, delivered either at Oracle or at a customer designated location. Our Oracle On Demand business model is rapidly evolving and we may not be able to compete effectively or generate significant revenues. Our Oracle On Demand business is subject to a variety of risks including:
| • | we may not be able to operate this business at an acceptable profit level; | |
| • | because we manage critical customer applications we could be exposed to significant damage claims in the event of system failures or inadequate disaster recovery; | |
| • | because Oracle On Demand results in our management of customer data and other confidential information, we have increased exposure to risk of claims around data security and privacy and misappropriation of customer confidential information; | |
| • | if we are unable to meet application availability requirements, provide adequate disaster recovery and provide agreed upon data security and privacy threshold standards, we may not be able to attract new customers and we could lose existing customers; | |
| • | the laws and regulations applicable to hosted service providers are unsettled and we could have regulatory exposure in certain areas such as data privacy, data security, export compliance and workforce reduction claims as a result of customers transferring their information technology functions to us; and | |
| • | as our Oracle On Demand business grows, we will need to continue to invest in various aspects of our on demand offering, including data centers, computers, network infrastructure and security. |
If we are unable to successfully exploit this business our future operating results could be adversely affected.
Business disruptions could affect our future operating results. Our operating results and financial condition could be materially and adversely affected in the event of a major earthquake, fire or other catastrophic event. We are a highly automated business and a disruption or failure of our systems could cause delays in completing sales and providing services, including Oracle On Demand. A significant portion of our research and development activities and certain other critical business operations are concentrated in a few geographic areas. A catastrophic event that results in the destruction or disruption of any of our critical business or information technology systems could severely affect our ability to conduct normal business operations and as a result our future operating results could be adversely affected.
We may have exposure to additional tax liabilities. As a multinational corporation, we are subject to income taxes as well as non-income based taxes, in both the United States and various foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes and other tax liabilities.
In the ordinary course of a global business, there are many intercompany transactions and calculations where the ultimate tax determination is uncertain. We are regularly under audit by tax authorities. Our intercompany transfer prices are currently being reviewed by the IRS and by foreign tax jurisdictions and will likely be subject to additional audits in the future. We previously negotiated two Advance Pricing Agreements with the IRS that cover many of our intercompany transfer prices and preclude the IRS from making a transfer pricing adjustment within the scope of these agreements. The agreements, however, are only effective for fiscal years through May 31, 2001, do not cover all elements of our transfer pricing and do not bind tax authorities outside
41
Although we believe that our tax estimates are reasonable, we cannot assure you that the final determination of our tax audits and litigation will not be different from what is reflected in our historical income tax provisions and accruals.
We have exposure to additional non-income tax liabilities. We are subject to non-income taxes, such as payroll, sales, use, value-added, net worth, property and goods and services taxes, in both the United States and various foreign jurisdictions. We are regularly under audit by tax authorities with respect to these non-income taxes.
Our stock price could remain volatile and your investment could lose value. Our stock price has fluctuated widely in the past and could continue to do so in the future. Your investment in our stock could lose value. Some of the factors that could significantly affect the market price of our stock include:
| • | quarterly variations in our results of operations or those of our competitors; | |
| • | changes in our or our competitors’ prices; | |
| • | changes in our revenue and revenue growth rates as a whole or for specific geographic areas, business units, products or product categories; | |
| • | announcements of new products or product enhancements by us or our competitors; | |
| • | announcements regarding our planned acquisition and integration of PeopleSoft; | |
| • | announcements regarding other acquisitions; | |
| • | announcements of advances in technology by us or our competitors; | |
| • | changes in management; | |
| • | changes in recommendations or earnings estimates by financial analysts; | |
| • | speculation in the press or analyst community; | |
| • | changes in political, economic and market conditions either generally or specifically to particular industries; | |
| • | fluctuations in stock prices generally, particularly with respect to the stock prices for other technology companies; | |
| • | changes in interest rates; and | |
| • | changes in investors’ beliefs as to the appropriate price-earnings ratio or other valuation measure for our competitors and us. |
A significant drop in our stock price could expose us to the risk of securities class action lawsuits. Defending against such lawsuits could result in substantial costs and divert management’s attention and resources. Furthermore, any settlement or adverse determination of these lawsuits could adversely affect us.
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Interest Rate Risk. All of our fixed income investments, with the exception of auction rate securities, are classified as held-to-maturity, and therefore, are reported on the balance sheet at amortized cost. Auction rate securities are classified as available-for-sale and reported on the balance sheet at par value, which equals market value, as the rate on such securities re-sets generally every 7 to 28 days. Consequently, interest rate movements do not affect the balance sheet valuation of the fixed income investments. Changes in the overall level of interest rates affect our interest income that is generated from our investments. For the three months ended November 30, 2004, total interest income was $42.9 million with investments yielding an average 1.87%
42
Table of Investment Securities:
The table below presents the cash, cash equivalent and investment balances, related weighted average interest rates and maturities for our investment portfolio at November 30, 2004. The cash, cash equivalent and investment balances approximate fair value at November 30, 2004.
| Amortized | Weighted Average | ||||||||
| (Dollars in millions) | Principal Amount | Interest Rate | |||||||
|
Cash and cash equivalents
|
$ | 5,905 | 2.23% | ||||||
|
Short-term investments (91 days-1 year)
|
3,531 | 1.51% | |||||||
|
Total cash, cash equivalents and investments
|
$ | 9,436 | 1.96% | ||||||
The table above includes the United States dollar equivalent of cash, cash equivalents and investments, a portion of which is denominated in foreign currencies as shown below. See discussion of our foreign currency risk below for a description of how we hedge net assets of certain international subsidiaries from foreign currency exposure.
| Amortized | |||||
| Principal | |||||
| Amount at | |||||
| (in millions) | November 30, 2004 | ||||
|
Euro
|
$ | 499 | |||
|
Japanese Yen
|
868 | ||||
|
British Pound
|
153 | ||||
|
Chinese Renminbi
|
175 | ||||
|
Canadian Dollar
|
87 | ||||
|
South African Rand
|
55 | ||||
|
Australian Dollar
|
84 | ||||
|
Other currencies
|
548 | ||||
|
Total cash, cash equivalents and short-term
investments denominated in foreign currencies
|
$ | 2,469 | |||
During fiscal 1997, we issued $150.0 million in 6.91% senior notes due in February 2007. In February 2002, we entered into an interest-rate swap agreement that has the economic effect of modifying the interest obligations associated with these senior notes so that the interest payable on the senior notes effectively becomes variable based on the three month LIBOR set on February 15, May 15, August 15 and November 15 of each year until maturity. The notional amount of the interest rate swap and the termination date match the principal amounts and maturity date of the outstanding senior notes. Our interest rate swap reduced the effective interest rate on our 6.91% senior notes to 4.10% as of November 30, 2004. The fair value of the interest rate swap is $5.6 million at November 30, 2004 and is included in other assets in the accompanying consolidated balance sheets.
Foreign Currency Transaction Risk. We transact business in various foreign currencies and have established a program that primarily utilizes foreign currency forward contracts to offset the risk associated with the effects of certain foreign currency exposures. Under this program, increases or decreases in our foreign currency exposures are offset by gains or losses on the forward contracts to mitigate the possibility of foreign currency transaction gains or losses. These foreign currency exposures typically arise from intercompany sublicense fees and other intercompany transactions. Our forward contracts generally have terms of 90 days or less. We do not use forward contracts for trading purposes. All outstanding foreign currency forward contracts (excluding our Yen equity hedge described below) are marked to market at the end of the period with unrealized gains and losses included in other income, net. Our ultimate realized gain or loss with respect to
43
Net Investment Risk. Periodically, we hedge the net assets of certain international subsidiaries (net investment hedges) using foreign currency forward contracts to offset the translation and economic exposures related to our investments in these subsidiaries. We measure the ineffectiveness of net investment hedges by using the changes in spot exchange rates because this method reflects our risk management strategies and the economics of those strategies in our financial statements and better manages interest rate differentials between different countries. Under this method, the change in fair value of the forward contract attributable to the changes in spot exchange rates (the effective portion) is reported in stockholders’ equity to offset the translation results on the net investments. The remaining change in fair value of the forward contract (the ineffective portion) is recognized in other income, net.
At November 30, 2004, we had one net investment hedge in Japanese Yen. The Yen investment hedge minimizes currency risk arising from net assets held in Yen as a result of equity capital raised during the initial public offering and secondary offering of Oracle Japan. The fair value of our Yen investment hedge was $2.2 million and $0.5 million as of November 30, 2004 and 2003. The Yen investment hedge has a notional amount of $647.1 million and an exchange rate of 102.00 Yen for each United States dollar.
Net losses on investment hedges reported in stockholders’ equity were $55.9 million and $48.4 million in the six months ended November 30, 2004 and 2003, respectively. Net gains on investment hedges reported in other income, net were $5.2 million and $3.7 million in the six months ended November 30, 2004 and 2003, respectively.
| Item 4. | Controls and Procedures |
Evaluation of Disclosure Controls and Procedures. Our Chief Executive Officer and our Chief Financial Officer, after evaluating the effectiveness of the Company’s “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 (Exchange Act) Rules 13a-15(e) or 15d-15(e)) as of the end of the period covered by this quarterly report, have concluded that our disclosure controls and procedures are effective based on their evaluation of these controls and procedures required by paragraph (b) of Exchange Act Rules 13a-15 or 15d-15.
Changes in Internal Control Over Financial Reporting. There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Section 404 Assessment. Section 404 of the Sarbanes-Oxley Act of 2002 requires management’s annual review and evaluation of our internal controls, and an attestation of the effectiveness of these controls by our independent registered public accountants beginning with our Form 10-K for the fiscal year ending on May 31, 2005. We are dedicating significant resources, including management time and effort, and incurring substantial costs in connection with our ongoing Section 404 assessment. We are currently documenting and testing our internal controls and considering whether any improvements are necessary for maintaining an effective control environment at our company. The evaluation of our internal controls is being conducted under the direction of our senior management. In addition, our management is regularly discussing the results of our testing and any proposed improvements to our control environment with our Finance and Audit Committee. We will continue to work to improve our controls and procedures, and to educate and train our employees on our existing controls and procedures in connection with our efforts to maintain an effective controls infrastructure at our Company.
Limitations on Effectiveness of Controls. A system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the system will meet its objectives. The design of a
44
PART II. OTHER INFORMATION
| Item 1. | Legal Proceedings |
The material set forth in Note 10 of Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q is incorporated herein by reference.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
In the second quarter of fiscal 2005, we sold an aggregate of 13,209 shares of our common stock to eligible employees of Oracle EMEA Limited, an indirect subsidiary of the Company, who are participants in the Oracle Ireland Approved Profit Sharing Scheme (the Ireland APSS) at an aggregate purchase price of approximately $147,000. We purchased the shares in the open market at the same price the shares were sold to the Ireland APSS participants and paid customary brokerage commissions of approximately $1,000 in connection with the purchase. There were no underwriting discounts or commissions in connection with the sale. The Ireland APSS permits an eligible employee to receive shares of common stock in a tax efficient manner as a portion of such employee’s bonus, as well as to contribute a portion of their base salary and Flex Euro allowance towards the purchase of additional shares in certain circumstances. The securities are held in trust for the employees for a minimum of two years. The shares of common stock were offered and sold in reliance upon Section 4(2) of the Securities Act of 1933, as amended, and the safe harbor provided by Rule 903 of Regulation S under the Securities Act, to employees of Oracle EMEA Ltd who are not “U.S. Persons” as that term is defined in Regulation S.
Stock Repurchase Program
In 1992, our Board of Directors approved a program to repurchase shares of our common stock to reduce the dilutive effect of our stock option and stock purchase plans. The Board has expanded the repurchase program several times by either increasing the authorized number of shares to be repurchased or by authorizing a fixed dollar amount expansion, most recently in October 2004, when the Board authorized an additional $2.0 billion. From the inception of the stock repurchase program in 1992 to November 30, 2004, a total of 1,768.2 million shares have been repurchased for approximately $20.1 billion. At November 30, 2004, approximately $2.2 billion was available to repurchase shares of our common stock pursuant to the stock repurchase program.
The following table summarizes the stock repurchase activity for the three months ending November 30, 2004, and the approximate dollar value of shares that may yet be purchased pursuant to the stock repurchase program:
| Total Number of | Approximate Dollar | ||||||||||||||||
| Total Number | Average | Shares Purchased | Value of Shares that | ||||||||||||||
| of Shares | Price Paid | as Part of Publicly | May Yet Be Purchased | ||||||||||||||
| (in millions, except per share amounts) | Purchased | Per Share | Announced Program | Under the Program | |||||||||||||
|
September 1,
2004 - September 30, 2004
|
— | $ | — | — | $ | 708.5 | |||||||||||
|
October 1, 2004 - October 31,
2004
|
24.4 | 12.32 | 24.4 | 2,408.5 | |||||||||||||
|
November 1,
2004 - November 30, 2004
|
19.2 | 13.09 | 19.2 | 2,157.1 | |||||||||||||
|
Total
|
43.6 | $ | 12.66 | 43.6 | |||||||||||||
45
| Item 4. | Submission of Matters to a Vote of Security Holders |
Set forth is information concerning each matter submitted to a vote at the Annual Meeting of Stockholders on October 29, 2004.
Proposal No. 1: The stockholders elected each of the following persons as a director to hold office until the 2005 Annual Meeting of Stockholders or until earlier retirement, resignation or removal.
| Votes For | Votes Withheld | |||||||
| Director’s Name | (in millions) | (in millions) | ||||||
|
Jeffrey O. Henley
|
4,344 | 140 | ||||||
|
Lawrence J. Ellison
|
4,377 | 107 | ||||||
|
Donald L. Lucas
|
4,355 | 129 | ||||||
|
Michael J. Boskin
|
4,346 | 138 | ||||||
|
Jack F. Kemp
|
4,422 | 62 | ||||||
|
Jeffrey S. Berg
|
4,308 | 176 | ||||||
|
Safra Catz
|
4,346 | 138 | ||||||
|
Hector Garcia-Molina
|
4,355 | 129 | ||||||
|
Joseph A. Grundfest
|
4,355 | 129 | ||||||
|
H. Raymond Bingham
|
4,242 | 242 | ||||||
|
Charles E. Phillips, Jr.
|
4,347 | 137 | ||||||
Proposal No. 2: The stockholders approved the adoption of the Company’s Fiscal Year 2005 Executive Bonus Plan with 4,325.4 million affirmative votes, 125.4 million negative votes and 33.0 million votes abstaining.
Proposal No. 3: The stockholders ratified the appointment of Ernst and Young LLP as the Company’s independent registered public accounting firm for the fiscal year ended May 31, 2005 with 4,421.1 million affirmative votes, 36.3 million negative votes and 26.5 million votes abstaining.
Proposal No. 4: The stockholders approved the Company’s Amended and Restated 2000 Long-Term Equity Incentive Plan with 2,982.1 million affirmative votes, 339.3 million negative votes, 34.3 million votes abstaining and 1,128.2 million broker non-votes.
Proposal No. 5: The stockholders voted against a stockholder proposal to adopt the “China Business Principles for Rights of Workers in China” with 2,872.4 million negative votes, 173.9 million affirmative votes, 309.4 million votes abstaining and 1,128.2 million broker non-votes.
| Item 5. | Other Information |
The forms of agreements we enter into each fiscal year with our chief executive officer and our four other most highly compensated executive officers (determined by reference to compensation for each preceding fiscal year and hereinafter referred to as the “named executive officers”) under our Executive Bonus Plan are filed as exhibits to this Form 10-Q. Exhibit 10.15 is our form of non-sales Executive Bonus Plan agreement, and Exhibit 10.16 is our form of sales and consulting Executive Bonus Plan agreement.
The Executive Bonus Plan provides for the payment of cash bonuses to eligible senior officers based upon the attainment of certain performance criteria established by the Committee on Compensation and Management Development of the Board of Directors. The criteria established for our named executive officers for fiscal year 2005 include operating profit growth, license revenue growth, outsourcing bookings growth and licensing and consulting margins. The individual agreements specify which criteria apply to each covered participant.
The maximum bonus payment under the Executive Bonus Plan that any participant can receive in fiscal year 2005 is $7,500,000 less any other cash compensation (including base salary) she or he receives during fiscal year 2005 (i.e., total cash compensation cannot exceed $7,500,000 in fiscal year 2005).
46
| Item 6. | Exhibits |
| Exhibit | ||
| Number | Exhibit Title | |
|
10.15
|
Form of Executive Bonus Plan Agreement for the Oracle Executive Bonus Plan, Non-Sales | |
|
10.16
|
Form of Executive Bonus Plan Agreement for the Oracle Executive Bonus Plan, Sales and Consulting | |
|
10.17
|
Oracle Corporation 1993 Deferred Compensation Plan, as amended and restated as of November 14, 2003 | |
|
31.01
|
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act—Lawrence J. Ellison | |
|
31.02
|
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act—Harry L. You | |
|
32.01
|
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act |
47
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, Oracle Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| ORACLE CORPORATION |
|
Dated: December 21, 2004
|
By: /s/ HARRY L. YOU Harry L. You, Executive Vice President and Chief Financial Officer |
|
|
Dated: December 21, 2004
|
By: /s/ JENNIFER L. MINTON Jennifer L. Minton, Senior Vice President, Finance and Operations and Chief Accounting Officer |
|
48
EXHIBIT INDEX
| Exhibit | ||
| Number | Exhibit Title | |
|
10.15
|
Form of Executive Bonus Plan Agreement for the Oracle Executive Bonus Plan, Non-Sales | |
|
10.16
|
Form of Executive Bonus Plan Agreement for the Oracle Executive Bonus Plan, Sales and Consulting | |
|
10.17
|
Oracle Corporation 1993 Deferred Compensation Plan, as amended and restated as of November 14, 2003 | |
|
31.01
|
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act— Lawrence J. Ellison | |
|
31.02
|
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act— Harry L. You | |
|
32.01
|
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act |