Form 10-Q
Table of Contents


UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

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, 2005

 

OR

 

¨  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

(Exact name of registrant as specified in its charter)

 

Delaware   94-2871189

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification no.)

 

500 Oracle Parkway

Redwood City, California 94065

(Address of principal executive offices, including zip code)

 

(650) 506-7000

(Registrant’s telephone number, including area code)

 

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 ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES x  NO ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ¨  NO x

 

The number of shares of registrant’s common stock outstanding as of December 30, 2005 was: 5,162,025,333.

 




Table of Contents

ORACLE CORPORATION

 

FORM 10-Q QUARTERLY REPORT

 


 

TABLE OF CONTENTS

 

          Page

PART I.  FINANCIAL INFORMATION     
Item 1.    Financial Statements (Unaudited)     
     Condensed Consolidated Balance Sheets as of November 30, 2005 and May 31, 2005    1
     Condensed Consolidated Statements of Operations for the Three and Six Months Ended November 30, 2005 and 2004    2
     Condensed Consolidated Statements of Cash Flows for the Six Months Ended November 30, 2005 and 2004    3
     Notes to Condensed Consolidated Financial Statements    4
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    22
Item 3.    Quantitative and Qualitative Disclosures About Market Risk    59
Item 4.    Controls and Procedures    61
PART II.  OTHER INFORMATION     
Item 1.    Legal Proceedings    62
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds    62
Item 4.    Submission of Matters to a Vote of Security Holders    63
Item 5.    Other Information    63
Item 6.    Exhibits    64
     Signatures    65


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item  1. Financial Statements

 

ORACLE CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

As of November 30, 2005 and May 31, 2005

(Unaudited)

 

(in millions, except per share data)


  

November 30,

2005


   

May 31,

2005


 

ASSETS

                

Current assets:

                

Cash and cash equivalents

   $ 2,837     $ 3,894  

Marketable securities

     566       877  

Trade receivables, net of allowances of $275 and $269

     1,976       2,570  

Other receivables

     229       330  

Deferred tax assets

     471       486  

Prepaid expenses and other current assets

     187       291  
    


 


Total current assets

     6,266       8,448  
    


 


Non-current assets:

                

Property, net

     1,366       1,442  

Intangible assets, net

     3,269       3,373  

Goodwill

     7,366       7,003  

Deferred tax assets

     51       32  

Other assets

     1,028       389  
    


 


Total non-current assets

     13,080       12,239  
    


 


Total assets

   $ 19,346     $ 20,687  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY

                

Current liabilities:

                

Short-term borrowings and current portion of long-term debt

   $ 907     $ 2,693  

Accounts payable

     240       230  

Income taxes payable

     667       904  

Accrued compensation and related benefits

     699       923  

Accrued restructuring

     73       156  

Deferred revenues

     2,183       2,289  

Other current liabilities

     794       868  
    


 


Total current liabilities

     5,563       8,063  
    


 


Non-current liabilities:

                

Notes payable and long-term debt, net of current portion

     156       159  

Deferred tax liabilities

     950       1,010  

Accrued restructuring

     91       120  

Deferred revenues

     89       126  

Other long-term liabilities

     382       372  
    


 


Total non-current liabilities

     1,668       1,787  
    


 


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: 5,154 shares at November 30, 2005 and 5,145 shares at May 31, 2005

     6,887       6,596  

Retained earnings

     5,063       4,043  

Deferred compensation

     (29 )     (45 )

Accumulated other comprehensive income

     194       243  
    


 


Total stockholders’ equity

     12,115       10,837  
    


 


Total liabilities and stockholders’ equity

   $ 19,346     $ 20,687  
    


 


 

See notes to condensed consolidated financial statements.

 

1


Table of Contents

ORACLE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

For the Three and Six Months Ended November 30, 2005 and 2004

(Unaudited)

 

    

Three Months Ended

November 30,


    

Six Months Ended

November 30,


 

(in millions, except per share data)


   2005

       2004

     2005

       2004

 

Revenues:

                                       

New software licenses

   $ 1,058        $ 971      $ 1,687        $ 1,534  

Software license updates and product support

     1,559          1,252        3,061          2,427  
    


    


  


    


Software revenues

     2,617          2,223        4,748          3,961  

Services

     675          533        1,312          1,010  
    


    


  


    


Total revenues

     3,292          2,756        6,060          4,971  
    


    


  


    


Operating expenses:

                                       

Sales and marketing

     706          555        1,321          1,035  

Software license updates and product support

     175          141        335          277  

Cost of services

     582          449        1,145          868  

Research and development

     468          320        868          623  

General and administrative

     109          130        265          255  

Amortization of intangible assets

     126          7        249          16  

Acquisition related

     10          23        38          52  

Restructuring

                     11           
    


    


  


    


Total operating expenses

     2,176          1,625        4,232          3,126  
    


    


  


    


Operating income

     1,116          1,131        1,828          1,845  

Interest expense

     (16 )        (6 )      (37 )        (11 )

Non-operating income, net

     22          29        63          58  
    


    


  


    


Income before provision for income taxes

     1,122          1,154        1,854          1,892  

Provision for income taxes

     324          339        538          568  
    


    


  


    


Net income

   $ 798        $ 815      $ 1,316        $ 1,324  
    


    


  


    


Earnings per share:

                                       

Basic

   $ 0.15        $ 0.16      $ 0.26        $ 0.26  
    


    


  


    


Diluted

   $ 0.15        $ 0.16      $ 0.25        $ 0.25  
    


    


  


    


Weighted-average common shares outstanding:

                                       

Basic

     5,152          5,123        5,150          5,139  
    


    


  


    


Diluted

     5,238          5,218        5,241          5,229  
    


    


  


    


 

See notes to condensed consolidated financial statements.

 

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Table of Contents

ORACLE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Six Months Ended November 30, 2005 and 2004

(Unaudited)

 

    

Six Months Ended

November 30,


 

(in millions)


   2005

    2004

 

Cash Flows From Operating Activities:

                

Net income

   $ 1,316     $ 1,324  

Adjustments to reconcile net income to net cash provided by operating activities:

                

Depreciation

     110       89  

Amortization of intangible assets

     249       16  

Deferred income taxes

     (65 )     (42 )

Minority interests in income

     17       19  

Amortization of stock-based compensation

     20        

In-process research and development

     12        

Changes in assets and liabilities, net of effects from acquisitions:

                

Decrease in trade receivables

     558       527  

Decrease in prepaid expenses and other assets

     158       152  

Decrease in accounts payable and other liabilities

     (308 )     (267 )

(Decrease) increase in income taxes payable

     (219 )     38  

Decrease in deferred revenues

     (92 )     (57 )
    


 


Net cash provided by operating activities

     1,756       1,799  
    


 


Cash Flows From Investing Activities:

                

Purchases of marketable securities

     (926 )     (5,097 )

Proceeds from maturities and sale of marketable securities

     1,203       6,011  

Acquisitions, net of cash acquired

     (498 )      

Purchase of equity investment

     (605 )      

Capital expenditures

     (86 )     (92 )

Proceeds from sale of property

     89        

Increase in other assets

     (3 )     (4 )
    


 


Net cash (used for) provided by investing activities

     (826 )     818  
    


 


Cash Flows From Financing Activities:

                

Payments for repurchase of common stock

     (324 )     (1,095 )

Proceeds from issuance of common stock

     245       165  

Proceeds from borrowings

     6,518        

Payments of debt

     (8,321 )      

Distributions to minority interests

     (23 )     (26 )
    


 


Net cash used for financing activities

     (1,905 )     (956 )
    


 


Effect of exchange rate changes on cash and cash equivalents

     (82 )     106  
    


 


Net (decrease) increase in cash and cash equivalents

     (1,057 )     1,767  

Cash and cash equivalents at beginning of period

     3,894       4,138  
    


 


Cash and cash equivalents at end of period

   $ 2,837     $ 5,905  
    


 


Non-cash financing transactions:

                

Fair value of options and stock issued in connection with acquisitions

   $ 33     $ 12  

 

See notes to condensed consolidated financial statements.

 

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Table of Contents

ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

November 30, 2005

(Unaudited)

 

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, as amended, for the fiscal year ended May 31, 2005.

 

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, 2006. 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 under stockholder approved stock option programs and provide employees the right to purchase our stock pursuant to 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 FASB Statement No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure. For pro forma disclosures, the estimated fair value of the unvested 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 reported 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

November 30,


   

Six Months Ended

November 30,


 

(in millions, except per share data)


   2005

    2004

    2005

    2004

 

Net income, as reported

   $ 798     $ 815     $     1,316     $     1,324  

Add:         Stock-based employee compensation expense included in net income, net of related tax effects

     5             13        

Deduct:    Stock-based employee compensation expense determined under the fair value based method for awards, net of forfeitures and related tax effects (1)

     (39 )     (41 )     (73 )     (79 )
    


 


 


 


Pro forma net income

   $ 764     $ 774     $ 1,256     $ 1,245  
    


 


 


 


Earnings per share:

                                

Basic—as reported

   $     0.15     $     0.16     $ 0.26     $ 0.26  

Basic—pro forma

   $ 0.15     $ 0.15     $ 0.24     $ 0.24  

Diluted—as reported

   $ 0.15     $ 0.16     $ 0.25     $ 0.25  

Diluted—pro forma

   $ 0.15     $ 0.15     $ 0.24     $ 0.24  

(1) Includes reversal of unearned stock compensation expense for forfeitures arising from our use of the accelerated expense attribution method, net of related tax effects, of $4.9 million and $19.8 million in the three and six months ended November 30, 2005 and $4.8 million and $7.9 million for the three and six months ended November 30, 2004.

 

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Table of Contents

ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

November 30, 2005

(Unaudited)

 

We estimate the fair value of our options using a Black-Scholes-Merton 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 values of employee and director stock options granted were estimated at the date of grant using the following weighted-average assumptions:

 

    

Three Months Ended

November 30,


   

Six Months Ended

November 30,


 

   2005

    2004

    2005

    2004

 

Expected life (in years)

     2.50-7.15       2.31-5.31       2.50-7.15       2.28-6.54  

Risk-free interest rate

     4.26-4.41 %     3.00-3.69 %     3.78-4.41 %     2.40-3.69 %

Volatility

     28 %     34 %     27-28 %     34-36 %

Dividend yield

                        

Weighted-average fair value of grants

   $ 4.85     $ 3.26     $ 4.53     $ 3.42  

 

The fair value of the option component of the employee purchase plan shares was estimated at the date of grant using a Black-Scholes-Merton option-pricing model. The following weighted-average assumptions were used in the three and six months ended November 30, 2004, respectively: expected life of 0.50 years, risk-free interest rate of 1.69%, volatility of 37% and dividend yield of 0%. The weighted average fair value of employee purchase plan grants was $3.09 for the three and six months ended November 30, 2004. We modified the terms of our employee stock purchase plan in April 2005 to eliminate the option component associated with the plan and to reduce the discount from 15% to 5%.

 

3. NEW ACCOUNTING PRONOUNCEMENTS

 

Share-Based Payment:  On December 16, 2004, the FASB issued Statement No. 123 (revised 2004), Share-Based Payment, which is a revision of Statement 123. Statement 123(R) supersedes Opinion 25, and amends FASB Statement No. 95, Statement of Cash Flows. Generally, the approach in Statement 123(R) is similar to the approach described in Statement 123. However, Statement 123(R) generally requires share-based payments to employees, including grants of employee stock options and purchases under employee stock purchase plans, to be recognized in the statement of operations based on their fair values. Pro forma disclosure of fair value recognition will no longer be an alternative.

 

Statement 123(R) permits public companies to adopt its requirements using one of two methods:

 

    Modified prospective method: Compensation cost is recognized beginning with the effective date of adoption (a) based on the requirements of Statement 123(R) for all share-based payments granted after the effective date of adoption and (b) based on the requirements of Statement 123 for all awards granted to employees prior to the effective date of adoption that remain unvested on the date of adoption.

 

    Modified retrospective method: Includes the requirements of the modified prospective method described above, but also permits restatement using amounts previously disclosed under the pro forma provisions of Statement 123 either for (a) all prior periods presented or (b) prior interim periods of the year of adoption.

 

On April 14, 2005, the Securities and Exchange Commission announced that the Statement 123(R) effective transition date would be extended to annual periods beginning after June 15, 2005. We are required to adopt this new standard on June 1, 2006, with early-adoption permitted.

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

November 30, 2005

(Unaudited)

 

Statement 123(R) also requires the benefits of tax deductions in excess of recognized compensation expense to be reported as a financing cash flow, rather than as an operating cash flow as prescribed under current accounting rules. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. Total cash flow will remain unchanged from what would have been reported under prior accounting rules.

 

As permitted by Statement 123, we currently account for share-based payments to employees using Opinion 25’s intrinsic value method. As a consequence, we generally recognize no compensation cost for employee stock options and purchases under our Employee Stock Purchase Plan. Although the adoption of Statement 123(R)’s fair value method will have no adverse impact on our balance sheet or total cash flows, it will affect our net income and earnings per share. The actual effects of adopting Statement 123(R) will depend on numerous factors including the amounts of share-based payments granted in the future, the valuation model we use to value future share-based payments to employees and estimated forfeiture rates. See Note 2 for the effect on reported net income and earnings per share if we had accounted for our stock option and stock purchase plans using the fair value recognition provisions of Statement 123.

 

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, Accounting for Nonmonetary Transactions. 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 was effective for nonmonetary asset exchanges beginning in our second quarter of fiscal 2006. The adoption of Statement 153 did not have a material effect on our consolidated financial position, results of operations or cash flows.

 

Accounting Changes and Error Corrections: On June 7, 2005, the FASB issued Statement No. 154, Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20, Accounting Changes, and Statement No. 3, Reporting Accounting Changes in Interim Financial Statements. Statement 154 changes the requirements for the accounting for and reporting of a change in accounting principle. Previously, most voluntary changes in accounting principles required recognition of a cumulative effect adjustment within net income of the period of the change. Statement 154 requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. Statement 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005; however, the Statement does not change the transition provisions of any existing accounting pronouncements. We do not believe adoption of Statement 154 will have a material effect on our consolidated financial position, results of operations or cash flows.

 

Amortization Period for Leasehold Improvements: On June 29, 2005, the FASB ratified the EITF’s Issue No. 05-06, Determining the Amortization Period for Leasehold Improvements. Issue 05-06 provides that the amortization period used for leasehold improvements acquired in a business combination or purchased after the inception of a lease be the shorter of (a) the useful life of the assets or (b) a term that includes required lease periods and renewals that are reasonably assured upon the acquisition or the purchase. The provisions of Issue 05-06 were effective on a prospective basis for leasehold improvements purchased or acquired beginning in our second quarter of fiscal 2006. The adoption of Issue 05-06 did not have a material effect on our consolidated financial position, results of operations or cash flows.

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

November 30, 2005

(Unaudited)

 

4. ACQUISITIONS

 

Fiscal 2006 Acquisitions

 

Investment in i-flex Solutions Limited

 

On August 2, 2005, we entered into a Share Purchase Agreement with OrbiTech Limited, a subsidiary of Citigroup Inc. for the purchase of 32,236,000 shares of i-flex Solutions Limited, a provider of software solutions and services to the financial services industry (Bombay Stock Exchange: IFLX.BO and National Stock Exchange of India: IFLX.NS). Under the terms of the Share Purchase Agreement and related agreements, we purchased the i-flex shares from OrbiTech on November 18, 2005 for $593 million, or 800 Indian rupees per share. As a result of this purchase and additional purchases of i-flex common stock pursuant to an open offer in October 2005, our investment in i-flex is $605 million as of November 30, 2005, which represents 43% of the outstanding common stock of i-flex.

 

We account for our investment in i-flex under the equity method of accounting. Under the equity method of accounting, we record our percentage interest of the earnings of i-flex in other income, net. We record such amounts two months in arrears as our reporting periods differ and the access to more current information is not available. As a result, we have not reflected any equity in earnings of i-flex for the three and six months ended November 30, 2005. We plan to record our percentage interest in the earnings of i-flex for its quarter ending December 31, 2005 in our third fiscal quarter ending February 28, 2006. Our investment in i-flex reflects the price paid for the common stock recently purchased and, therefore, it differs from the underlying interest in the net assets of i-flex, which is based on U.S. GAAP. As we are unable to relate this difference to specific accounts of i-flex, the difference has been recognized in a similar manner as goodwill and will not be subject to amortization. The market value of our investment, which was $707 million at November 30, 2005, was in excess of the carrying value of our investment of $605 million, which is recorded in other assets, net in the condensed consolidated balance sheets.

 

Other Acquisitions

 

During the first half of fiscal 2006, we acquired several software companies and purchased certain technology and development organizations for approximately $545 million, which includes cash paid of $512 million and the fair value of options assumed of $33 million.

 

We recorded approximately $368 million of goodwill, $145 million of identifiable intangible assets, $20 million of net tangible assets and $12 million of in-process research and development in connection with these other acquisitions during the first half of fiscal 2006. We have included the effects of these transactions in our results of operations prospectively from the respective dates of the acquisitions. Pro forma financial information for acquisitions accounted for as business combinations has not been presented, as the effects were not material to our historical consolidated financial statements either individually or in aggregate.

 

Fiscal 2005 Acquisitions

 

PeopleSoft, Inc.

 

Pursuant to our Agreement and Plan of Merger with PeopleSoft Inc., a Delaware corporation, dated December 12, 2004, we acquired approximately 75% and 97% of the outstanding common stock of PeopleSoft (including shares subject to guaranteed delivery) for $26.50 per share in cash as of December 29, 2004 and January 6, 2005, respectively. On January 7, 2005, we completed the merger of our wholly-owned subsidiary

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

November 30, 2005

(Unaudited)

 

with and into PeopleSoft and converted each remaining outstanding share of PeopleSoft common stock not tendered, into a right to receive $26.50 per share in cash, without interest.

 

The total purchase price was $11.1 billion, which consisted of $10,576 million in cash paid or payable to acquire the outstanding common stock of PeopleSoft, $492 million for the fair value of options assumed and $12 million in cash for transaction costs. In allocating the purchase price based on estimated fair values, we recorded approximately $6,480 million of goodwill, $3,384 million of identifiable intangible assets, $1,183 million of net tangible assets and $33 million of in-process research and development. The preliminary allocation of the purchase price was based, in part, upon a valuation and our estimates and assumptions are subject to change. The primary areas of the purchase price allocation that are not yet finalized relate to certain legal matters, income and non-income based taxes and residual goodwill.

 

Pro Forma Financial Information

 

The unaudited financial information in the table below summarizes the combined results of operations of Oracle and PeopleSoft, on a pro forma basis, as though the companies had been combined as of the beginning of the period presented. The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of the period presented. The pro forma financial information includes the business combination accounting effect on historical PeopleSoft support revenues, adjustments to depreciation on acquired property, the charge for in-process research and development, amortization charges from acquired intangible assets, stock-based compensation charges for unvested options assumed, Oracle restructuring costs, acquisition and tender offer costs reflected in Oracle’s and PeopleSoft’s historical statements of operations for periods prior to our Agreement and Plan of Merger, adjustments to interest expense and related tax effects.

 

The unaudited pro forma financial information combines the historical results for Oracle with the historical results for PeopleSoft for the three and six months ended November 30, 2004.

 

(in millions, except per share data)


  

Three Months Ended

November 30, 2004


  

Six Months Ended

November 30, 2004


Total revenues

   $ 3,322    $ 6,011

Net income

   $ 595    $ 798

Basic net income per share

   $ 0.12    $ 0.16

Diluted net income per share

   $ 0.11    $ 0.15

 

Retek Inc.

 

We purchased 5.5 million shares of common stock of Retek Inc., a Delaware Corporation, on March 7 and 8, 2005, through ordinary brokerage transactions at prevailing market prices for a weighted-average price of $8.82 per share. In April and May 2005, we acquired the remaining outstanding common stock of Retek for $11.25 per share, or $584 million.

 

The total purchase price was $701 million, comprised of $633 million of cash paid to acquire the outstanding common stock of Retek, $32 million of cash paid for outstanding stock options and $36 million of acquisition related transaction costs. In allocating the purchase price based on estimated fair values, we recorded approximately $430 million of goodwill, $133 million of identifiable intangible assets, $131 million of net tangible assets and $7 million of in-process research and development. The preliminary allocation of the

 

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Table of Contents

ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

November 30, 2005

(Unaudited)

 

purchase price was based upon a valuation and our estimates and assumptions are subject to change. The primary areas of the purchase price allocation that are not yet finalized relate to certain legal matters as well as income and non-income based taxes. Pro forma financial information for Retek has not been presented, as the effects were not material to our consolidated financial statements.

 

5. RESTRUCTURING ACTIVITIES

 

During fiscal 2005, management approved and initiated plans to restructure the pre-merger operations of Oracle, PeopleSoft and Retek to eliminate certain duplicative activities, focus on strategic product and customer bases and reduce our cost structure. We have completed our planned legal-entity mergers, information system conversions and integration of PeopleSoft’s and Retek’s operations. We also have completed all exit activities associated with the pre-merger operations of Oracle.

 

Fiscal 2005 Oracle Restructuring Plan

 

The total restructuring costs associated with exit activities of pre-merger Oracle are $161 million. We have incurred $158 million in restructuring expenses to date, including $11 million in the first half of fiscal 2006. The following table reflects the activities of the fiscal 2005 Oracle restructuring plan for the six months ended November 30, 2005 and total costs incurred to date by operating segment:

 

    

Accrued
Restructuring

at May 31,
2005


   Six Months Ended
November 30, 2005


   

Accrued
Restructuring

at November 30,
2005 (3)


   Total Costs
Incurred
to Date


   Total
Expected
Program
Costs


(in millions)


      Total Costs
Incurred


  

Cash

Payments


         

Employee severance

                                          

New software licenses

   $ 14    $ 1    $ (13 )   $ 2    $ 37    $ 38

Software license updates and product support

     1           (1 )          6      6

Consulting

     6      1      (5 )     2      20      21

On Demand (1)

                          2      2

Education

     2      3      (3 )     2      6      7

Other (2)

     6      6      (5 )     7      66      66
    

  

  


 

  

  

Total severance

   $ 29    $ 11    $ (27 )   $ 13    $ 137    $ 140
    

  

  


 

  

  

Facilities

                                          

New software licenses

   $ 2    $    $     $ 2    $ 2    $ 2

Software license updates and product support

     1                 1      1      1

Consulting

     2                 2      2      2

On Demand (1)

     1                 1      1      1

Other (2)

     15           (2 )     13      15      15
    

  

  


 

  

  

Total facilities

   $ 21    $    $ (2 )   $ 19    $ 21    $ 21
    

  

  


 

  

  

Total Oracle restructuring

   $ 50    $ 11    $ (29 )   $ 32    $ 158    $ 161
    

  

  


 

  

  


(1) Formerly referred to as advanced product services.
(2) Other includes severance and facility charges associated with research and development, general and administrative and marketing functions.
(3) Accrued restructuring of $32 million at November 30, 2005 includes $14 million recorded in accrued restructuring, current and $18 million, related to long-term facilities obligations, recorded in accrued restructuring, non-current in the accompanying condensed consolidated balance sheets.

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

November 30, 2005

(Unaudited)

 

Fiscal 2005 PeopleSoft and Retek Restructuring Plan

 

We currently estimate total restructuring costs associated with exiting activities of PeopleSoft and Retek to approximate $393 million. The following table reflects the activities of the PeopleSoft and Retek restructuring plan for the six months ended November 30, 2005, total costs accrued to date and total expected program costs:

 

(in millions)


  

Accrued
Restructuring

at May 31,
2005


   Six Months Ended November 30, 2005

   

Accrued
Restructuring

at
November 30,
2005 (2)


   Total
Costs
Accrued
to Date


   Total
Expected
Program
Costs


      Adjustments
to Accrual (1)


   

Cash

Payments


    Translation
Adjustments


         

Severance

   $ 63    $ (18 )   $ (33 )   $ (1 )   $ 11    $ 193    $ 193

Facilities

     143      (6 )     (30 )     (3 )     104      152      152

Other

     20      9       (12 )           17      48      48
    

  


 


 


 

  

  

Total PeopleSoft and Retek Restructuring

   $ 226    $ (15 )   $ (75 )   $ (4 )   $ 132    $ 393    $ 393
    

  


 


 


 

  

  


(1) Primarily relates to changes in estimates related to severance payments, facility plans and other restructuring obligations relating to the PeopleSoft acquisition.
(2) Accrued restructuring of $132 million at November 30, 2005 includes $59 million recorded in accrued restructuring, current and $73 million, related to long-term facilities obligations, recorded in accrued restructuring, non-current in the accompanying condensed consolidated balance sheets.

 

6. ACQUISITION RELATED CHARGES

 

Acquisition related charges primarily consist of in-process research and development expenses, integration-related professional services, stock-compensation expenses and personnel related costs for transitional employees, as well as costs associated with our tender offer for PeopleSoft prior to the agreement date. Stock-based compensation included in acquisition related charges resulted from unvested options assumed in the PeopleSoft acquisition whose vesting was fully accelerated upon termination of the employees pursuant to the terms of these options.

 

      

Three Months Ended

November 30,


    

Six Months Ended

November 30,


(in millions)


     2005

   2004

     2005

   2004

In-process research and development

     $ 4    $      $ 12    $

Transitional employee related costs

       5             11     

Stock-based compensation

       1             4     

Professional fees

            23        11      52
      

  

    

  

Total acquisition related charges

     $       10    $       23      $       38    $       52
      

  

    

  

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

November 30, 2005

(Unaudited)

 

7. BORROWINGS

 

Borrowings consisted of the following:

 

(in millions)


   November 30,
2005


  

     May 31,     

2005


Commercial paper notes with various maturities through December 2005, net of unamortized discount of $1 and $7

   $ 489    $ 1,993

OTC Loan Facility due May 2006

     418      700
    

  

Short-term borrowings and current portion of long-term debt

     907      2,693

6.91% senior notes due February 2007

     150      153

Notes payable due May 2007

     6      6
    

  

Notes payable and long-term debt

     156      159
    

  

Total borrowings

   $ 1,063    $ 2,852
    

  

 

Short-Term Borrowings

 

In April 2005, we issued and sold unsecured short-term promissory notes with an aggregate principal face value of $2.0 billion (the CP Notes), under our $3.0 billion commercial paper program (CP Program). The CP Notes were issued and sold pursuant to a private placement exemption from the registration requirements under federal and state securities laws. The CP Notes, which were issued at a discount from their principal face value, have various maturities with different yields. The average weighted yield of the CP Notes outstanding at November 30, 2005 is 4.13%. The CP Notes are not redeemable prior to maturity and are not subject to voluntary prepayment.

 

In May 2005, Oracle Technology Company (OTC), a wholly-owned subsidiary, entered into an unsecured $700 million loan facility (OTC Loan Facility) with ABN AMRO Bank N.V. guaranteed by us. The effective interest rate on the OTC Loan Facility was 4.47% at November 30, 2005. All amounts under the OTC Loan Facility are due in May 2006.

 

$150 Million Senior Notes

 

We have $150 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 quarterly until maturity. Our interest rate swap reduced the effective interest rate on the senior notes to 6.43% as of November 30, 2005. The fair value of the interest rate swap was $0.4 million at November 30, 2005 ($3.1 million at May 31, 2005) and is included in other assets in the accompanying condensed consolidated balance sheets.

 

364-Day Revolving Credit Agreement

 

On March 18, 2005, we entered into a 364-day revolving credit agreement (Credit Agreement). The Credit Agreement is unsecured and provides a $3.0 billion credit facility (Credit Facility) to support any commercial paper we may issue and for working capital and other general corporate purposes. We may borrow, prepay and re-borrow amounts under the Credit Facility at any time under the Credit Agreement. As of November 30, 2005, we had not borrowed any funds against the Credit Agreement.

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

November 30, 2005

(Unaudited)

 

We were in compliance with all covenants at November 30, 2005, including the requirement in the Credit Facility that our total net debt to total capitalization ratio not exceed 40%.

 

8. DEFERRED REVENUES

 

Deferred revenues consisted of the following:

 

(in millions)


   November 30,
2005


  

     May 31,     

2005


Software license updates and product support

   $ 1,926    $       1,985

Services

     190      225

New software licenses

     67      79
    

  

Deferred revenues, current

     2,183      2,289

Deferred revenues, non-current

     89      126
    

  

Total deferred revenues

   $ 2,272    $ 2,415
    

  

 

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 the fiscal quarter ending in May of each year. Deferred service revenues include prepayments for consulting, On Demand 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. Deferred revenues, non-current are comprised primarily of deferred software license updates and product support revenues.

 

In connection with purchase price allocations related to our acquisitions in fiscal 2005 and during the first half of fiscal 2006, we have estimated the fair values of the support obligations assumed. The estimated fair values of the support obligations assumed were determined using a cost-build up approach. The cost-build up approach determines fair value by estimating the costs relating to fulfilling the obligations plus a normal profit margin. The sum of the costs and operating profit approximates, in theory, the amount that we would be required to pay a third party to assume the support obligations. We recorded adjustments to reduce the carrying values of the deferred software license updates and product support revenues assumed by $447 million to $300 million, which represents our estimate of the fair value of the support obligations assumed. As a result, software license updates and product support revenues related to support contracts assumed in business acquisitions in the amount of $240 million, which would have been otherwise recorded by the acquired entities, were not recognized as revenue during the six months ended November 30, 2005. Historically, substantially all of our customers, including customers from acquired companies, renew their contracts when the contract is eligible for renewal. To the extent these underlying support contracts are renewed, we will recognize the revenue for the full value of the support contracts over the support periods, the majority of which are one year.

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

November 30, 2005

(Unaudited)

 

9. 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, 2005, a total of 1.8 billion shares have been repurchased for approximately $20.7 billion. We repurchased 24.1 million shares for $324 million and 93.9 million shares for $1,095 million during the six months ended November 30, 2005 and 2004, respectively. At November 30, 2005, approximately $1.6 billion was available to repurchase shares of our common stock pursuant to the stock repurchase program.

 

10. 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 28.9% and 29.0% for the three and six months ended November 30, 2005, respectively, and 29.4% and 30.0% for the three and six months ended November 30, 2004, respectively.

 

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. We are also under examination by numerous state and non-US tax authorities. We believe that we have adequately provided for any reasonably foreseeable outcome related to these audits.

 

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 three unilateral 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. However, these agreements, which are effective for fiscal years through May 31, 2006, 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 Advance Pricing Agreements to cover various periods from June 1, 2001 through May 31, 2008.

 

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Table of Contents

ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

November 30, 2005

(Unaudited)

 

11. 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

November 30,


  

Six Months Ended

November 30,


(in millions, except per share data)


   2005

   2004

   2005

   2004

Net income

   $ 798    $ 815    $ 1,316    $ 1,324
    

  

  

  

Weighted-average common shares outstanding

     5,152      5,123      5,150      5,139

Dilutive effect of employee stock plans

     86      95      91      90
    

  

  

  

Diluted weighted-average common shares outstanding

     5,238      5,218      5,241      5,229
    

  

  

  

Basic earnings per share

   $ 0.15    $ 0.16    $ 0.26    $ 0.26

Diluted earnings per share

   $ 0.15    $ 0.16    $ 0.25    $ 0.25

Shares subject to anti-dilutive options excluded from calculation (1)

     108      139      108      144

(1) These weighted-average shares relate to anti-dilutive stock options and could be dilutive in the future.

 

12. COMPREHENSIVE INCOME

 

Comprehensive income includes foreign currency translation gains and losses and 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

November 30,


    

Six Months Ended

November 30,


 

(in millions)


   2005

    2004

     2005

    2004

 

Net income

   $ 798     $ 815      $ 1,316     $ 1,324  

Net foreign currency translation (loss) gain

     (82 )     185        (94 )     195  

Unrealized gain (loss) on equity securities, net

     6              9       (1 )

Equity hedge gain (loss), net

     28       (27 )      37       (34 )
    


 


  


 


Comprehensive income

   $ 750     $ 973      $ 1,268     $ 1,484  
    


 


  


 


 

14


Table of Contents

ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

November 30, 2005

(Unaudited)

 

13. GOODWILL AND INTANGIBLE ASSETS

 

The changes in the carrying amount of goodwill, which is not deductible for tax purposes, for the six months ended November 30, 2005 were as follows:

 

(in millions)


   New Software
Licenses


   Software License
Updates and
Product Support


    Services

   Other

    Total

 

Balance as of May 31, 2005

   $ 1,220    $ 4,863     $ 445    $ 475     $ 7,003  

Allocation of goodwill (1)

     218      164       93      (475 )      

Goodwill acquired

     231      102       35            368  

Goodwill adjustments

          (5 )                (5 )
    

  


 

  


 


Balance as of November 30, 2005

   $ 1,669    $ 5,124     $ 573    $     $ 7,366  
    

  


 

  


 



(1) Represents goodwill associated with fourth quarter fiscal 2005 acquisitions, primarily Retek, that was allocated to operating segments upon finalization of our intangible asset valuations in the first quarter of fiscal 2006.

 

The changes in intangible assets for the six months ended November 30, 2005 were as follows:

 

(in millions)


   Intangible Assets, Gross

   Accumulated Amortization

    Net Book Value

   Weighted
Average
Useful
Life


   May 31,
2005


   Additions

   Nov 30,
2005


   May 31,
2005


    Expense

   

Nov 30,

2005


   

May 31,

2005


   Nov 30,
2005


  

Software support agreements and related relationships

   $ 2,124    $    14    $ 2,138    $ (88 )   $ (107 )   $ (195 )   $ 2,036    $ 1,943    10 years

Developed technology

     800    106      906      (127 )     (86 )     (213 )     673      693    5 years

Core technology

     368    18      386      (30 )     (38 )     (68 )     338      318    5 years

Customer relationships

     257    5      262      (11 )     (12 )     (23 )     246      239    10 years

Trademarks

     84    2      86      (4 )     (6 )     (10 )     80      76    7 years
    

  
  

  


 


 


 

  

    

Total

   $ 3,633    $  145    $ 3,778    $ (260 )   $ (249 )   $ (509 )   $ 3,373    $ 3,269     
    

  
  

  


 


 


 

  

    

 

The total amortization expense related to intangible assets was $126 million and $249 million for the three and six months ended November 30, 2005, respectively, and $7 million and $16 million for the three and six months ended November 30, 2004, respectively. Estimated future amortization expense related to intangible assets is as follows:

 

(in millions)


  

Year Ended

May 31,


2006 (remainder of fiscal year)

   $ 256

2007

     509

2008

     500

2009

     495

2010

     390

Thereafter

     1,119
    

Total

   $ 3,269
    

 

15


Table of Contents

ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

November 30, 2005

(Unaudited)

 

14. 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 have two businesses, software and services, 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) On Demand and (3) education.

 

The new software license line of business is engaged in the licensing of database and middleware software as well as applications software. Database and middleware software includes database management software, application server software, development tools and collaboration software. Applications software provides enterprise information that enables companies to manage their business cycles and provide intelligence in functional areas such as financials, human resources, maintenance management, manufacturing, marketing, order fulfillment, product lifecycle management, procurement, projects, sales, services and supply chain planning. 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 provides services to customers in the design, implementation, deployment and upgrade of our database, middleware and applications software. On Demand includes Oracle On Demand and Advanced Customer Services. Oracle On Demand provides multi-featured software and hardware management and maintenance services for our database, middleware and applications software. Advanced Customer Services provide 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, middleware and applications software.

 

We do not track our assets by operating segments. Consequently, it is not practical to show assets by operating segments.

 

16


Table of Contents

ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

November 30, 2005

(Unaudited)

 

The following table presents a summary of our businesses and operating segments:

 

    

Three Months Ended

November 30,


  

Six Months Ended

November 30,


(in millions)


   2005

   2004

   2005

   2004

New software licenses:

                           

Revenues (1)

   $ 1,056    $ 969    $ 1,683    $ 1,530

Sales and distribution expenses

     576      447      1,077      830
    

  

  

  

Margin (2)

   $ 480    $ 522    $ 606    $ 700

Software license updates and product support:

                           

Revenues (1)

   $ 1,661    $ 1,252    $ 3,302    $ 2,427

Cost of services

     165      134      317      264
    

  

  

  

Margin (2)

   $ 1,496    $ 1,118    $ 2,985    $ 2,163

Total software business:

                           

Revenues (1)

   $ 2,717    $ 2,221    $ 4,985    $ 3,957

Expenses

     741      581      1,394      1,094
    

  

  

  

Margin (2)

   $ 1,976    $ 1,640    $ 3,591    $ 2,863

Consulting:

                           

Revenues (1)

   $ 505    $ 393    $ 985    $ 746

Cost of services

     424      317      836      625
    

  

  

  

Margin (2)

   $ 81    $ 76    $ 149    $ 121

On Demand:

                           

Revenues (1)

   $ 87    $ 73    $ 171    $ 144

Cost of services

     79      55      151      106
    

  

  

  

Margin (2)

   $ 8    $ 18    $ 20    $ 38

Education:

                           

Revenues (1)

   $ 85    $ 69    $ 159    $ 124

Cost of services

     56      56      109      100
    

  

  

  

Margin (2)

   $ 29    $ 13    $ 50    $ 24

Total services business:

                           

Revenues (1)

   $ 677    $ 535    $ 1,315    $ 1,014

Cost of services

     559      428      1,096      831
    

  

  

  

Margin (2)

   $ 118    $ 107    $ 219    $ 183

Totals:

                           

Revenues (1)

   $ 3,394    $ 2,756    $ 6,300    $ 4,971

Expenses

     1,300      1,009      2,490      1,925
    

  

  

  

Margin (2)

   $ 2,094    $ 1,747    $ 3,810    $ 3,046
    

  

  

  


(1) 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. Additionally, software license updates and product support revenues for management reporting include $102 million and $240 million that was not recognized on the accompanying condensed consolidated statements of operations for the three and six months ended November 30, 2005, respectively. See Note 8 for an explanation of these adjustments and the following table for a reconciliation of operating segment revenues to total revenues.
(2) The margins reported reflect only the direct controllable costs and 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. Additionally, the margins do not reflect the amortization of intangible assets, restructuring costs, acquisition related costs and stock-based compensation.

 

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Table of Contents

ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

November 30, 2005

(Unaudited)

 

Reconciliation of operating segment revenues to total revenues

 

    

Three Months Ended

November 30,


  

Six Months Ended

November 30,


(in millions)


   2005

     2004

   2005

     2004

Total revenues for reportable segments

   $ 3,394      $ 2,756    $ 6,300      $ 4,971

Software license updates and product support revenues

     (102 )           (240 )     
    


  

  


  

Total revenues

   $ 3,292      $ 2,756    $ 6,060      $ 4,971
    


  

  


  

 

Reconciliation of operating segment margin to income before provision for income taxes

 

    

Three Months Ended

November 30,


    

Six Months Ended

November 30,


 

(in millions)


   2005

     2004

     2005

     2004

 

Total margin for reportable segments

   $ 2,094      $ 1,747      $ 3,810      $ 3,046  

Software license updates and product support revenues

     (102 )             (240 )       

Product development and information technology expenses

     (545 )      (385 )      (1,013 )      (757 )

Marketing and partner program expenses

     (111 )      (92 )      (205 )      (174 )

Corporate and general and administrative expenses

     (76 )      (110 )      (206 )      (198 )

Amortization of intangible assets

     (126 )      (7 )      (249 )      (16 )

Acquisition related

     (10 )      (23 )      (38 )      (52 )

Restructuring

                   (11 )       

Stock-based compensation

     (7 )             (16 )       

Interest expense

     (16 )      (6 )      (37 )      (11 )

Non-operating income, net

     21        30        59        54  
    


  


  


  


Income before provision for income taxes

   $ 1,122      $ 1,154      $ 1,854      $ 1,892  
    


  


  


  


 

15. PEOPLESOFT CUSTOMER ASSURANCE PROGRAM

 

In June 2003, in response to our tender offer, PeopleSoft implemented what it referred to as the “customer assurance program” or “CAP.” The CAP incorporated a provision in PeopleSoft’s standard licensing arrangement that purports to contractually burden Oracle, as a result of our acquisition of PeopleSoft, with a contingent obligation to make payments to PeopleSoft customers should we fail to take certain business actions for a fixed period. The payment obligation, which typically expires four years from the date of the contract, is fixed at an amount generally between two and five times the license and first year support fees paid to PeopleSoft in the applicable license transaction. PeopleSoft customers retain rights to the licensed products whether or not the CAP payments are triggered.

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

November 30, 2005

(Unaudited)

 

The maximum potential penalty under the CAP, by version, as of November 30, 2005 was as follows:

 

     Dates Offered to Customers (1)

 

Maximum Potential

Penalty (in millions)


 

CAP Version


   Start Date

   End Date

 

Version 1

   June 2003    September 12, 2003   $ 76  (2)

Version 2

   September 12, 2003    September 30, 2003     170  

Version 3

   September 30, 2003    November 7, 2003     40  

Version 4

   November 18, 2003    June 30, 2004     1,352  

Version 5

   June 16, 2004    December 28, 2004     792  

Version 6

   October 12, 2004    December 28, 2004     1,105  
             


              $ 3,535  
             



(1) Some contracts originally submitted to customers prior to these end dates were executed following such dates. The majority of the CAP provisions will expire no later than four years after the contract date.
(2) As of November 30, 2005, all but two contracts containing Version One of the CAP have expired by their terms. $76 million is the maximum potential payment under the two remaining Version 1 CAP contracts.

 

This purported obligation was not reflected as a liability on PeopleSoft’s balance sheet as PeopleSoft concluded that it could be triggered only following the consummation of an acquisition. We have concluded that, as of the date of the acquisition, the penalty provisions under the CAP represented a contingent liability of Oracle. The aggregate potential CAP obligation as of November 30, 2005 was $3.5 billion. Unless the CAP provisions are removed from these licensing arrangements, we do not expect the aggregate potential CAP obligation to decline substantially until fiscal year 2008 when these provisions begin to expire. We have not recorded a liability related to the CAP, as we do not believe it is probable that our post-acquisition activities related to the PeopleSoft product line will trigger an obligation to make any payment pursuant to the CAP. While no assurance can be given as to the ultimate outcome of litigation, we believe we would also have substantial defenses with respect to the legality and enforceability of the CAP contract provisions in response to any claims seeking payment from Oracle under the CAP terms.

 

16. LEGAL PROCEEDINGS

 

Securities Class Action

 

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. Between March 2002 and March 2003, the court dismissed plaintiffs’ consolidated complaint, first amended complaint and a revised second amended complaint. The last dismissal was with prejudice. 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 revised second amended complaint named our Chief Executive Officer, our then Chief Financial Officer (who currently is Chairman of our Board of Directors) and a former Executive Vice President as defendants. This complaint was brought on behalf of purchasers of our stock during the period from December 14, 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. Plaintiffs also allege that the defendants engaged in accounting violations. Currently, the parties are conducting discovery. Trial has been set for September 11, 2006. Plaintiffs seek unspecified damages plus interest, attorneys’ fees and costs,

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

November 30, 2005

(Unaudited)

 

and equitable and injunctive relief. We believe that we have meritorious defenses against this action, and we will continue vigorously to defend it.

 

Derivative Litigation

 

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. On November 24, 2004, the Delaware Court issued an opinion granting summary judgment in favor of the remaining defendants. On April 13, 2005, the Delaware Supreme Court unanimously upheld Court of Chancery’s grant of summary judgment.

 

Regarding the San Mateo Derivative Action, 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. On June 6, 2005, the San Mateo Court signed a stipulated order, dismissing our former Chief Financial Officer from the case. On June 9, 2005, our Chief Executive Officer brought a motion for summary judgment, and on August 15, 2005, the parties filed a stipulation withdrawing this motion. The parties reached a settlement, which was approved by the Court on November 22, 2005. In the settlement agreement, our Chief Executive Officer continued to deny all allegations in plaintiffs’ complaint, and he noted that the Delaware Chancery Court dismissed all of the claims against him. Nonetheless, our Chief Executive Officer agreed to the settlement, stating that it would eliminate the burden (to him and Oracle), expense, and uncertainties of further litigation and related distraction of resources and efforts from his business. Under the settlement, our Chief Executive Officer agreed to pay $22 million in plaintiffs’ legal fees and costs and agreed to make a $100 million contribution in Oracle’s name to a charity or institution to be approved by Oracle’s Board of Directors. After approving the settlement, the court entered a judgment of dismissal on November 22, 2005. That judgment is currently subject to possible appeal.

 

Litigation Related to the PeopleSoft Acquisition

 

In connection with our unsolicited offer for PeopleSoft, we were involved in several legal proceedings, all of which have been resolved. The 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. The other proceedings relating to the acquisition have all been dismissed.

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

November 30, 2005

(Unaudited)

 

Intellectual Property Litigation

 

Mangosoft, Inc. and Mangosoft Corporation filed a patent infringement action against us in the United States District Court for the District of New Hampshire on November 22, 2002. Plaintiffs alleged that we are willfully infringing U.S. Patent Nos. 6,148,377 (the ‘377 patent) and 5,918,229 (the ‘229 patent), which they claim to own. Plaintiffs seek damages based on our license sales of the Real Application Clusters database option, the 9i and 10g databases, and the Application Server, and seek injunctive relief. We have denied infringement and asserted affirmative defenses and have counterclaimed against plaintiffs for declaratory judgment that the ‘377 and ‘229 patents are invalid, unenforceable and not infringed by us. On May 19, 2004, the court held a claims construction (Markman) hearing, and on September 21, 2004, it issued a Markman order. On June 21, 2005, plaintiffs withdrew their allegations of infringement of the ‘229 patent. Discovery closed on July 1, 2005. Summary judgment motions were filed on August 25, 2005, and the court held a hearing on these motions on October 17, 2005. The court has not yet ruled on these motions. The court has not yet set a trial date.

 

Other Litigation

 

We are party to various legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business, including proceedings and claims that relate to acquisitions we have completed or to companies we have acquired or are attempting to acquire. 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.

 

17. PENDING ACQUISITION OF SIEBEL SYSTEMS, INC.

 

On September 12, 2005, we entered into a Merger Agreement to acquire Siebel Systems, Inc. The proposed transaction is valued at approximately $6.1 billion (based on a fully-diluted equity value). The transaction is conditioned upon (i) clearance under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, which occurred on November 15, 2005, and the applicable foreign antitrust laws of certain other jurisdictions, including the European Commission, which occurred on December 22, 2005, (ii) approval of the merger and adoption of the Merger Agreement by Siebel stockholders and (iii) other customary closing conditions.

 

Pursuant to the Merger Agreement, each share of Siebel common stock will be converted into the right to receive either (a) $10.66 in cash or (b) a number of shares of our common stock equal to $10.66 divided by the greater of (i) $10.72 or (ii) the average closing price of our common stock over the ten trading days immediately preceding (but not including) the closing date, provided that no more than 30% of the outstanding Siebel common stock may be converted into our common stock. If Siebel stockholders holding more than 30% of Siebel common stock elect to receive our stock, the equity consideration will be prorated. The stock election will not be available unless the holders of at least 6% of the outstanding Siebel common stock make the stock election. In addition, options to acquire Siebel common stock and Siebel restricted stock awards will be converted into options to acquire shares of our common stock based on formulas contained in the Merger Agreement.

 

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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, significant trends and acquisition activities. 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, as amended, for the fiscal year ended May 31, 2005 and the other Quarterly Reports on Form 10-Q to be filed by us in our fiscal year 2006, which runs from June 1, 2005 to May 31, 2006.

 

Business Overview

 

We are the world’s largest enterprise software company. We have two businesses, software and services, which are further organized into five operating segments. 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

 

Our software business is comprised of two operating segments: (1) new software license revenues and (2) software license updates and product support revenues. We expect that our software business revenues will continue to increase, which should allow us to continually improve margins and profits.

 

New Software Licenses:  We license our database, middleware 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, governmental budgetary constraints, the competitive position of our software products and acquisitions. The new software license 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 relatively 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 4-quarter period provides more visibility into the underlying performance of our software revenues than quarterly revenues. We believe that new software license margins will be affected by amortization of intangible assets associated with acquisitions, and as a result, will be lower than margins achieved prior to the acquisition of PeopleSoft.

 

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

 

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lowering the total cost of ownership of our software products by improving integration, decreasing installation times, lowering administration costs and improving the ease of use. Reducing the total cost of ownership of our products provides our customers with a higher return on their investment, which we believe will create more demand and provide us with a competitive advantage. We have also continued to focus on improving the overall quality of our software products and service levels. We believe this will lead to higher customer satisfaction and loyalty and help us achieve our goal of becoming our customers’ leading technology advisor.

 

Software License Updates and Product Support:  Customers that purchase software license updates and product support are granted rights to unspecified product upgrades and maintenance releases issued during the support period, as well as technical support assistance. Substantially all of our customers renew their software license updates and product support contracts annually, thereby eliminating the need to repurchase new software licenses when new upgrades are released. The growth of software license updates and product support revenues is influenced by four factors: (1) the support contract base of companies acquired (2) the renewal rate of the support contract base, (3) the amount of new support contracts sold in connection with the sale of new software licenses and (4) inflationary support price increases.

 

Software license updates and product support revenues, which represent approximately 46% of our total revenues on a trailing 4-quarter basis, is our highest margin business unit. Support margins over the last trailing 4-quarters were 89%, and account for 74% of our total margins over the same respective period. We believe that software license updates and product support revenues and margins will continue to grow for the following reasons:

 

    Recent acquisitions of software companies have significantly increased our support contract base, as well as the portfolio of products available to be licensed.

 

    Substantially all customers purchase license updates and product support subscriptions when they buy new software licenses, resulting in a further increase in our support subscription contract base. Even if license revenue growth was flat, software license updates and product support revenues would continue to grow assuming renewal and cancellation rates remained relatively constant since substantially all new software license transactions add to the support contract base.

 

    Substantially all of our customers, including customers from acquired companies, renew their support contracts when eligible for renewal.

 

    When support contract renewals are negotiated, inflationary price increases are assessed, where applicable.

 

As a result of the acquisition of PeopleSoft and other businesses, we recorded adjustments to reduce support obligations assumed in business acquisitions to their estimated fair value at the acquisition dates. Software license updates and product support revenues related to support contracts in the amount of $102 million and $240 million that would have been otherwise recorded by PeopleSoft and other acquired businesses as independent entities, were not recognized during the three and six months ended November 30, 2005, respectively. As these underlying support contracts are renewed, we will recognize the revenue for the full value of the support contracts over the support periods, the majority of which are one year.

 

Services Business

 

Our services business consists of consulting, On Demand (formerly referred to as advanced product services) and education revenues. Our services business, which represents 21% of our total revenues on a trailing 4-quarter basis, has significantly lower margins than our software business.

 

Consulting:  Consulting revenues tend to lag software revenues by several quarters since consulting services, if purchased, are typically performed after the purchase of new software licenses. Consulting revenues have been negatively impacted in recent periods for the following reasons:

 

    Continued attrition of personnel due to a demand for technical talent in certain markets, particularly in the United States.

 

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    A shift in the mix of resources to lower cost countries, which has resulted in a decrease in average billing rates.

 

    Our decision to work more closely with partners who perform implementations of our software.

 

Despite these trends, we expect consulting revenues to increase in fiscal 2006, primarily due to an increase in application implementations related to acquired products.

 

On Demand:  On Demand includes our Oracle On Demand ‘software as a service’ and outsourcing offerings as well as Advanced Customer Services. We believe that our On Demand offerings provide an additional opportunity for customers to lower their total cost of ownership and can therefore provide us with a competitive advantage. We will continue to make investments in Oracle On Demand 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 software revenues. Education revenues have been impacted by personnel reductions in our customers’ information technology departments, tighter controls over discretionary spending and greater use of outsourcing solutions. Despite these trends, we expect education revenues to increase in fiscal 2006, primarily due to an increase in customer training on the use of our application products.

 

Operating Margins

 

We continually focus on improving our operating margins by providing our customers with superior products and services, as well as maintaining a world class cost structure by hiring personnel in countries where advanced technical expertise is available at lower costs. As part of this effort, we continually evaluate our workforce and make adjustments we deem appropriate. When we make adjustments to our workforce, we may incur expenses associated with workforce reductions that delay the benefit of a more efficient workforce structure, but we believe that the fundamental shift towards globalization is crucial to maintaining a long-term competitive cost structure.

 

Acquisitions

 

In January 2005, we completed the acquisition of PeopleSoft Inc., a provider of enterprise application software products for approximately $11.1 billion. We have also acquired several other companies over the last two years. We have completed our planned legal-entity mergers, information system conversions and integration of PeopleSoft’s operations as well as our other acquisitions. In addition, we completed the acquisition of 43% of the outstanding common stock of i-flex Solutions Limited, a provider of software solutions and services to the financial services industry, for approximately $605 million in November 2005. See Note 4 of Notes to Condensed Consolidated Financial Statements for additional information related to our acquisitions.

 

An active acquisition program is an important element of our corporate strategy. We expect to continue to acquire companies, products, services and technologies. In September 2005, we agreed to purchase all of the outstanding shares of Siebel Systems, Inc. for $10.66 per share in cash or stock (up to 30%), for approximately $6.1 billion (based on a fully-diluted equity value). The Siebel acquisition is subject to a vote of their stockholders, regulatory approvals and other customary conditions. We expect that the transaction will close on January 31, 2006, or shortly thereafter, provided the foregoing conditions which have not yet been satisfied or waived are satisfied or waived. Including the Siebel acquisition, in the last two years, we have paid or agreed to pay an aggregate of approximately $19 billion for these acquisitions. We believe our recent acquisitions support our long-term strategic direction, strengthen our competitive position in the enterprise applications market, expand our customer base and provide greater scale to increase our investment in research and development to accelerate innovation and increase stockholder value.

 

We believe we can fund additional acquisitions with our internally available cash and marketable securities, cash generated from operations, amounts available under our commercial paper program, additional borrowings or from the issuance of additional securities. We analyze the financial impact of any potential acquisition with regard to earnings, operating margin, cash flow and return on invested capital targets.

 

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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:

 

    Business Combinations

 

    PeopleSoft Customer Assurance Program

 

    Goodwill

 

    Revenue Recognition

 

    Accounting for Income Taxes

 

    Legal Contingencies

 

    Stock-Based Compensation

 

    Allowances for Doubtful Accounts and Returns

 

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.

 

Business Combinations

 

In accordance with business combination accounting, we allocate the purchase price of acquired companies to the tangible and intangible assets acquired, liabilities assumed, as well as in-process research and development based on their estimated fair values. We engage third-party appraisal firms to assist management in determining the fair values of certain assets acquired and liabilities assumed. Such a valuation requires management to make significant estimates and assumptions, especially with respect to intangible assets.

 

Management makes estimates of fair value based upon assumptions believed to be reasonable. These estimates are based on historical experience and information obtained from the management of the acquired companies and are inherently uncertain. Critical estimates in valuing certain of the intangible assets include but are not limited to: future expected cash flows from license sales, maintenance agreements, consulting contracts, customer contracts and acquired developed technologies and patents; expected costs to develop the in-process research and development into commercially viable products and estimating cash flows from the projects when completed; the acquired company’s brand awareness and market position, as well as assumptions about the period of time the acquired brand will continue to be used in the combined company’s product portfolio; and discount rates. Unanticipated events and circumstances may occur which may affect the accuracy or validity of such assumptions, estimates or actual results.

 

In connection with purchase price allocations, we estimate the fair value of the support obligations assumed in connection with acquisitions. The estimated fair value of the support obligations is determined utilizing a cost build-up approach. The cost build-up approach determines fair value by estimating the costs related to fulfilling the obligations plus a normal profit margin. The estimated costs to fulfill the support obligations are based on the

 

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historical direct costs related to providing the support services and to correct any errors in the software products acquired. We do not include any costs associated with selling efforts or research and development or the related fulfillment margins on these costs. Profit associated with selling effort is excluded because the acquired entities would have concluded the selling effort on the support contracts prior to the acquisition date. The estimated research and development costs are not included in the fair value determination, as these costs are not deemed to represent a legal obligation at the time of acquisition. The sum of the costs and operating profit approximates, in theory, the amount that we would be required to pay a third party to assume the support obligation.

 

Software license updates and product support revenues related to support contracts assumed in business acquisitions in the amount of $102 million and $240 million, which would have been otherwise recorded by the acquired entities, were not recognized as revenue by Oracle during the three and six months ended November 30, 2005, respectively. Historically, substantially all of our customers, including customers from acquired companies, renew their contracts when the contract is eligible for renewal. To the extent these underlying support contracts are renewed, we will recognize the revenue for the full value of the support contracts over the support periods, the majority of which are one year. Had we included our estimated selling and research and development activities, and the associated margin for unspecified product upgrades and enhancements to be provided under our assumed support arrangements, the fair value of the support obligations would have been significantly higher than what we have recorded and we would have recorded a higher amount of software license updates and product support revenue historically and in future periods related to these assumed contracts.

 

Other significant estimates associated with the accounting for acquisitions include restructuring costs. Restructuring costs are primarily comprised of severance costs, costs of consolidating duplicate facilities and contract termination costs. Restructuring expenses are based upon plans that have been committed to by management but which are subject to refinement. To estimate restructuring expenses, management utilizes assumptions of the number of employees that would be involuntarily terminated and of future costs to operate and eventually vacate duplicate facilities. Estimated restructuring expenses may change as management executes the approved plan. Decreases to the estimates of executing the currently approved plans associated with pre-merger activities of the companies we acquire are recorded as an adjustment to goodwill indefinitely, whereas increases to the estimates are recorded as an adjustment to goodwill during the purchase price allocation period (generally within one year of the acquisition date) and as operating expenses thereafter. Changes in estimates of executing the currently approved plans associated with pre-merger activities of Oracle are recorded in restructuring expenses.

 

We have identified certain pre-acquisition contingencies, but we have yet to conclude whether the fair values for such contingencies are determinable. If, during the purchase price allocation period, we are able to determine the fair value of a pre-acquisition contingency, we will include that amount in the purchase price allocation. If, as of the end of the purchase price allocation period, we are unable to determine the fair value of a pre-acquisition contingency, we will evaluate whether to include an amount in the purchase price allocation based on whether it is probable a liability had been incurred and whether an amount can be reasonably estimated. After the end of the purchase price allocation period, any adjustment that results from a pre-acquisition contingency will be included in our operating results in the period in which the adjustment is determined.

 

PeopleSoft Customer Assurance Program

 

As discussed in Note 15 of Notes to Condensed Consolidated Financial Statements, in June 2003, in response to our tender offer, PeopleSoft implemented what it referred to as the “customer assurance program” or “CAP.” The CAP incorporated a provision in PeopleSoft’s standard licensing arrangement that purports contractually to burden Oracle, as a result of our acquisition of PeopleSoft, with a contingent obligation to make payments to PeopleSoft customers should we fail to take certain business actions for a fixed period, which typically expires four years from the date of the contract. We have concluded that, as of the date of the acquisition, the penalty provisions under the CAP represent a contingent liability of Oracle. We have not recorded a liability related to the CAP, as we do not believe it is probable that our post-acquisition activities related to the PeopleSoft product line will trigger an obligation to make any payment pursuant to the CAP. The maximum potential penalty under

 

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the CAP as of November 30, 2005 was $3.5 billion. Unless the CAP provisions are removed from these licensing arrangements, we do not expect the aggregate potential CAP obligation to decline substantially until fiscal year 2008 when these provisions begin to expire. While no assurance can be given as to the ultimate outcome of potential litigation, we believe we would also have substantial defenses with respect to the legality and enforceability of the CAP contract provisions in response to any claims seeking payment from Oracle under the CAP terms. If we determine in the future that a payment pursuant to the CAP is probable, the estimated liability would be recorded in our operating results in the period in which such liability is determined.

 

Goodwill

 

We review goodwill for impairment annually and whenever events or changes in circumstances indicate its carrying value may not be recoverable in accordance with FASB Statement No. 142, Goodwill and Other Intangible Assets. The provisions of Statement 142 require that a two-step impairment test be performed on goodwill. In the first step, we compare the fair value of each reporting unit to its carrying value. Our reporting units are consistent with the reportable segments identified in Note 14 of the Notes to Condensed Consolidated Financial Statements. If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is considered not impaired and we are not required to perform further testing. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then we must perform the second step of the impairment test in order to determine the implied fair value of the reporting unit’s goodwill. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, then we would record an impairment loss equal to the difference.

 

Determining the fair value of a reporting unit is judgmental in nature and involves the use of significant estimates and assumptions. These estimates and assumptions include revenue growth rates and operating margins used to calculate projected future cash flows, risk-adjusted discount rates, future economic and market conditions and determination of appropriate market comparables. We base our fair value estimates on assumptions we believe to be reasonable but that are unpredictable and inherently uncertain. Actual future results may differ from those estimates. In addition, we make certain judgments and assumptions in allocating shared assets and liabilities to determine the carrying values for each of our reporting units. Our most recent annual goodwill impairment analysis, which was performed during the fourth quarter of fiscal 2005, did not result in an impairment charge.

 

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, On Demand and education revenues.

 

New software license revenues represent all fees earned from granting customers licenses to use our database, middleware 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

 

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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. 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 proportional performance 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 proportional performance 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.

 

On Demand is comprised of Oracle On Demand and Advanced Customer Services. Oracle On Demand provides multi-featured software and hardware management and maintenance services for our database, middleware and applications software. Advanced Customer Services are earned by providing customers configuration and performance analysis, personalized support and annual on-site technical services. On Demand 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

 

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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.

 

Substantially all of our software license arrangements 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 receivables with payment terms that generally extend up to five years from the contract date. Provided all other revenue recognition criteria have been met, we recognize new software license revenues for these arrangements upon delivery, net of any payment discounts from financing transactions. We have generally sold receivables financed through our financing division on a non-recourse basis to third party financing institutions. We account for the sale of these receivables as “true sales” as defined in FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.

 

Our customers include several of our suppliers and on rare occasion, we have purchased goods or services for our operations from these vendors at or about the same time that we have licensed our software to these same companies (a “Concurrent Transaction”). Software license agreements that occur within a three-month time period from the date we have purchased goods or services from that same customer are reviewed for appropriate

 

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accounting treatment and disclosure. When we acquire goods or services from a customer, we negotiate the purchase separately from any software license transaction, at terms we consider to be at arm’s length, and settle the purchase in cash. We recognize new software license revenue from Concurrent Transactions if all of our revenue recognition criteria are met and the goods and services acquired are necessary for our current operations.

 

During the three months ended November 30, 2005 we recognized new software license revenue of approximately $33 million from a supplier. We are currently negotiating to acquire goods and services from this supplier and expect to finalize terms of the purchase during the three months ended February 28, 2006. We currently estimate the value of the goods and services we will acquire from this supplier under this agreement to total approximately $20 million over the next five years.

 

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 from 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.

 

Our effective tax rate includes the impact of certain undistributed foreign earnings for which no U.S. taxes have been provided because such earnings are planned to be indefinitely reinvested outside the United States. Remittances of foreign earnings to the U.S. are planned based on projected cash flow, working capital and investment needs of foreign and domestic operations. Based on these assumptions, we estimate the amount that will be distributed to the United States and provide U.S. federal taxes on these amounts. Material changes in our estimates could impact our effective tax rate.

 

We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. In order for us to realize our deferred tax assets, we must be able to generate sufficient taxable income in those jurisdictions where the deferred tax assets are located. We have considered future market growth, forecasted earnings, future taxable income, the mix of earnings in the jurisdictions in which we operate and prudent and feasible tax planning strategies in determining the need for a valuation allowance. In the event we were to determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to earnings in the period in which we make such determination. Likewise, if we later determine that it is more likely than not that the net deferred tax assets would be realized, we would reverse the applicable portion of the previously provided valuation allowance.

 

We calculate our current and deferred tax provision based on estimates and assumptions that could differ from the actual results reflected in income tax returns filed during the subsequent year. Adjustments based on filed returns are generally recorded in the period when the tax returns are filed and the global tax implications are known.

 

The amount of income tax we pay is subject to ongoing audits by federal, state and foreign tax authorities, which often result in proposed assessments. Our estimate for the potential outcome for any uncertain tax issue is highly judgmental. We believe we have adequately provided for any reasonably foreseeable outcome related to these matters. However, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are made or resolved, audits are closed or when statutes of limitation on potential assessments expire. Additionally, the jurisdictions in which our earnings or deductions are realized may differ from our current estimates. As a result, our effective tax rate may fluctuate significantly on a quarterly basis.

 

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As part of our accounting for business combinations, some of the purchase price is allocated to goodwill and intangible assets. Impairment charges associated with goodwill will not be tax deductible and will result in an increased effective income tax rate in the quarter the impairment is recorded. Amortization expense associated with acquired intangible assets is likewise not tax deductible; however, deferred taxes have been recorded as part of the purchase price allocation and, therefore, will not affect our post-acquisition income tax rate. Income tax contingencies existing as of the acquisition dates of the acquired companies are evaluated quarterly and any adjustments are recorded as an adjustment to goodwill.

 

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.

 

Stock-Based Compensation

 

We currently measure compensation expense for our stock-based incentive programs using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. Under this method, we do not record compensation expense when stock options are granted to eligible participants as long as the exercise price is not less than the fair market value of the stock when the option is granted. In accordance with FASB Statement No. 123, Accounting for Stock-Based Compensation, and FASB Statement No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, we disclose our pro forma net income or loss and net income or loss per share as if the fair value-based method had been applied in measuring compensation expense for our stock-based incentive programs. We have elected to follow Opinion 25 because the fair value accounting provided for under Statement 123 requires the use of option valuation models that were not developed for use in valuing incentive stock options and employee stock purchase plan shares.

 

On December 16, 2004, the FASB issued Statement No. 123 (revised 2004), Share-Based Payment, which is a revision of Statement 123. Statement 123(R) generally requires share-based payments to employees, including grants of employee stock options and purchases under employee stock purchase plans, to be recognized in the statement of operations based on their fair values. This standard is effective for public companies for fiscal years beginning after June 15, 2005. We are required to adopt this new standard on June 1, 2006, with early-adoption permitted.

 

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 recorded 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. 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.

 

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Results of Operations

 

The fluctuations in operating results of Oracle in the second quarter and first half of fiscal 2006 compared with the same periods in fiscal 2005 are generally due to acquisitions made in the second half of fiscal 2005, principally PeopleSoft.

 

In our discussion of changes in our results of operations from the second quarter and first half of fiscal 2006 compared to the second quarter and first half of fiscal 2005, we quantify the amount of new software licenses and software license updates and product support revenues associated with PeopleSoft products and services and present supplemental disclosure related to acquisition accounting. Although certain revenues were quantifiable, we are unable to allocate the costs associated with the PeopleSoft products and services because the substantial majority of former PeopleSoft sales and services personnel were fully integrated into our existing operations. We caution readers that, while pre- and post-acquisition comparisons as well as the quantified amounts themselves may provide indications of general trends, the information has inherent limitations for the following reasons:

 

    The quantification cannot address the substantial effects attributable to our sales force integration efforts, in particular the effect of having a single sales force offer the Oracle and PeopleSoft product families on a neutral basis. The commissions earned by our integrated sales force did not vary based on the application product family sold. We believe that if our sales forces had not been integrated, the relative mix of Oracle and PeopleSoft products sold would have been different.

 

    The acquisition did not result in our entering a new line of business or product category. Therefore, we provided multiple products with substantially similar features and functionality.

 

    Although substantially all of our customers, including customers from acquired companies, renew their contracts when the contract is eligible for renewal, amounts shown as support deferred revenue in our supplemental disclosure related to acquisition accounting are not necessarily indicative of revenue improvements we will achieve upon contract renewal to the extent customers do not renew.

 

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 May 31, 2005, which was the last day of our 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, 2005 and November 30, 2004, our financial statements would reflect revenues of $1.17 million for the six months ended November 30, 2005 (using 1.17 as the exchange rate) and $1.31 million for the six months ended November 30, 2004 (using 1.31 as the exchange rate). The constant currency presentation would translate the results for the six months ended November 30, 2005 and 2004 using the May 31, 2005 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.

 

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Total Revenues and Operating Expenses

 

     Three Months Ended November 30,

   Six Months Ended November 30,

          Percent Change

             Percent Change

    

(Dollars in millions)


       2005    

   Actual

   Constant

       2004    

       2005    

   Actual

   Constant

       2004    

Total Revenues by Geography:

                                               

Americas

   $ 1,733    34%    33%    $ 1,292    $ 3,209    35%    33%    $ 2,384

EMEA (1)

     1,090    3%    9%      1,062      1,972    7%    11%      1,839

Asia Pacific

     469    17%    21%      402      879    18%    18%      748
    

            

  

            

Total revenues

     3,292    19%    22%      2,756      6,060    22%    23%      4,971

Total Operating Expenses

     2,176    34%    36%      1,625      4,232    35%    36%      3,126
    

            

  

            

Total Operating Margin

   $ 1,116    -1%    2%    $ 1,131    $ 1,828    -1%    1%    $ 1,845
    

            

  

            

Total Operating Margin %

     34%                41%      30%                37%

% Revenues by Geography:

                                               

Americas

     53%                47%      53%                48%

EMEA

     33%                38%      33%                37%

Asia Pacific

     14%                15%      14%                15%

Total Revenues by Business:

                                               

Software

   $ 2,617    18%    20%    $ 2,223    $ 4,748    20%    21%    $ 3,961

Services

     675    26%    29%      533      1,312    30%    31%      1,010
    

            

  

            

Total revenues

   $ 3,292    19%    22%    $ 2,756    $ 6,060    22%    23%    $ 4,971
    

            

  

            

% Revenues by Business:

                                               

Software

     80%                81%      78%                80%

Services

     20%                19%      22%                20%

(1) Comprised of Europe, the Middle East and Africa

 

Fiscal Second Quarter 2006 Compared to Fiscal Second Quarter 2005: Total revenues were negatively affected by foreign currency rate fluctuations of 3 percentage points due to a strengthening 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, software license updates and product support revenues contributed 55% to the growth in total revenues, whereas consulting and new software license revenues contributed 20% and 19%, respectively. On a constant currency basis, the Americas contributed 70% to the increase in total revenues, EMEA contributed 16% and Asia Pacific contributed 14%.

 

Operating expenses were favorably affected by 2 percentage points as a result of the strengthening of the United States dollar relative to other major international currencies. Excluding the effect of currency rate fluctuations, the increase in operating expenses is primarily due to higher headcount levels and associated personnel related costs in sales and marketing, consulting and research and development. In addition, the amortization of intangible assets acquired in the PeopleSoft acquisition contributed to the overall increase in total operating expenses. As a result, operating margins as a percentage of total revenues decreased from 41% to 34%.

 

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.

 

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First Half Fiscal 2006 Compared to First Half Fiscal 2005:  Total revenues were negatively affected by foreign currency rate fluctuations of 1 percentage point. Excluding the effect of currency rate fluctuations, software license updates and product support revenues contributed 57% to the growth in total revenues, whereas consulting and new software license revenues contributed 22% and 15%, respectively. On a constant currency basis, the Americas contributed 70% to the increase in total revenues, EMEA contributed 18% and Asia Pacific contributed 12%.

 

Operating expenses were favorably affected by 1 percentage point. Excluding the effect of currency rate fluctuations, the increase in operating expenses is primarily due to the same reasons noted above. As a result, operating margins as a percentage of total revenues decreased from 37% to 30%.

 

Supplemental Disclosure Related to Acquisition Accounting

 

To supplement our consolidated financial information we believe the following information is helpful to an overall understanding of our past financial performance and prospects for the future. Readers are directed to the introduction under “Results of Operations” for a discussion of the inherent limitations in comparing pre- and post-acquisition information.

 

The results of operations include the following purchase accounting adjustments and significant expenses incurred in connection with acquisitions:

 

         Three Months Ended    
November 30,


   

    Six Months Ended    

November 30,


 

(in millions)


   2005

    2004

    2005

    2004

 

Support deferred revenue (1)

   $ 102     $     $ 240     $  

Amortization of intangible assets (2)

     126       7       249       16  

Acquisition related charges (3) (5)

     10       23       38       52  

Restructuring (4)

                 11        

Stock-based compensation (5)

     7             16        

Income tax effect (6)

     (71 )     (8 )     (160 )     (20 )
    


 


 


 


     $ 174     $ 22     $ 394     $ 48  
    


 


 


 



(1) In connection with our purchase price allocations, we estimated the fair value of support obligations assumed in connection with business acquisitions made during fiscal 2005 and the first half of fiscal 2006. Due to our application of business combination accounting rules, software license updates and product support revenues related to support contracts assumed in business acquisitions in the amount of $102 million and $240 million, which would have been otherwise recorded by the acquired entities, were not recognized as revenue by Oracle during the three and six months ended November 30, 2005, respectively. Estimated software license updates and product support revenues related to support contracts assumed that will not be recognized due to the application of business combination accounting rules in future periods are as follows:

 

(in millions)


  

Year Ended

May 31,


2006 (remainder of fiscal year)

   $ 56

2007

     35

2008

     9
    

Total

   $ 100
    

 

To the extent customers renew these support contracts, we expect to recognize revenue for the full contract value over the support renewal period.

 

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(2) Primarily represents the amortization of intangible assets acquired in connection with our acquisition of PeopleSoft. Estimated future amortization expense related to intangible assets is as follows:

 

(in millions)


  

Year Ended

May 31,


2006 (remainder of fiscal year)

   $ 256

2007

     509

2008

     500

2009

     495

2010

     390

Thereafter

     1,119
    

Total

   $ 3,269
    

 

(3) Acquisition related charges primarily consist of in-process research and development expenses, integration-related professional services, stock-compensation expenses and personnel related costs for transitional employees, as well as costs associated with our tender offer for PeopleSoft prior to the agreement date.

 

(4) Restructuring costs relate to Oracle employee severance and facility closures in connection with our third quarter of fiscal 2005 restructuring plan, which has been completed as of November 30, 2005.

 

(5) Stock-based compensation is included in the following operating expense line items of our condensed consolidated statements of operations:

 

    

Three Months Ended

November 30,


  

Six Months Ended

November 30,


(in millions)


   2005

   2004

   2005

   2004

Sales and marketing

   $ 1    $    $ 3    $

Software license updates and product support

               1     

Cost of services

     2           4     

Research and development

     4           8     
    

  

  

  

Subtotal

     7           16     

Acquisition related charges

     1           4     
    

  

  

  

Total

   $ 8    $    $ 20    $
    

  

  

  

 

As of November 30, 2005, the portion of the intrinsic value of unvested options assumed from acquired companies related to future service, which is approximately $29 million, is recorded as deferred stock-based compensation on our consolidated balance sheet and will be amortized using the accelerated expense attribution method over the remaining vesting period, which averages 2.2 years.

 

Stock-based compensation included in acquisition related charges resulted from unvested options assumed in the PeopleSoft acquisition whose vesting was fully accelerated upon termination of the employees pursuant to the terms of these options.

 

(6) The income tax effect on purchase accounting adjustments and other significant expenses incurred in connection with acquisitions was calculated based on our effective tax rate of 28.9% and 29.4% in the second quarter of fiscal 2006 and 2005, respectively, and 29.0% and 30.0% in the first half of fiscal 2006 and 2005, respectively.

 

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Software

 

Software 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 and middleware products, as well as application software products. 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,

         2005    

   Percent Change

       2004    

       2005    

   Percent Change

       2004    

(Dollars in millions)


      Actual

   Constant

         Actual

   Constant

  

New Software License Revenues:

                                        

Americas

   $ 495    22%    21%    $ 405    $ 771    21%    19%    $ 637

EMEA

     359    -7%    0%      385      562    -2%    3%      572

Asia Pacific

     204    13%    18%      181      354    9%    10%      325
    

            

  

            

Total revenues

     1,058    9%    12%      971      1,687    10%    11%      1,534

Expenses:

                                               

Sales and marketing (1)

     705    27%    29%      555      1,318    27%    28%      1,035

Stock-based compensation

     1    *    *           3    *    *     

Amortization of intangible assets (2)

     45    *    *           85    *    *     
    

            

  

            

Total expenses

     751    35%    37%      555      1,406    36%    36%      1,035
    

            

  

            

Total Margin

   $ 307    -26%    -22%    $ 416    $ 281    -44%    -41%    $ 499
    

            

  

            

Total Margin %

     29%                43%      17%                33%

% Revenues by Geography:

                                               

Americas

     47%                42%      46%                42%

EMEA

     34%                40%      33%                37%

Asia Pacific

     19%                18%      21%                21%

Revenues by Product:

                                               

Database technology

   $ 785    5%    8%    $ 749    $ 1,278    3%    5%    $ 1,235

Applications

     266    24%    27%      215      393    39%    40%      283
    

            

  

            

Total revenues by product

     1,051    9%    12%      964      1,671    10%    11%      1,518

Other revenues

     7    *    *      7      16    *    *      16
    

            

  

            

Total new software license revenues

   $ 1,058    9%    12%    $ 971    $ 1,687    10%    11%    $ 1,534
    

            

  

            

% Revenues by Product:

                                               

Database technology

     75%                78%      76%                81%

Applications

     25%                22%      24%                19%

(1) Excluding stock-based compensation
(2) Included as a component of ‘Amortization of Intangible Assets’ in our condensed consolidated statements of operations
* Not meaningful

 

Fiscal Second Quarter 2006 Compared to Fiscal Second Quarter 2005:  New software license revenues were negatively affected by foreign currency rate fluctuations of 3 percentage points. Excluding the effect of currency rate fluctuations, the Americas and Asia Pacific contributed 72% and 28%, respectively, to the increase in new software license revenues, respectively, while EMEA revenues remained flat with prior year levels as a result of weak economic conditions and demand in Europe.

 

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We believe that the trailing 4-quarter growth rates more accurately reflect the underlying performance of our new software license business since large transactions can cause significant swings in our quarterly reported product revenue growth rates and are not predictive of our future quarterly or annual growth rates. Therefore, we provide a discussion of both quarterly and trailing 4-quarter product revenue growth rates.

 

Excluding the effect of currency rate fluctuations, database and middleware revenues grew 5% and 10% in the second quarter and on a trailing 4-quarter basis, respectively. Database revenues increased 5% and 9% in the second quarter and on a trailing 4-quarter basis, respectively. The growth in database revenues was primarily driven by increased demand for database option products, which grew 26% and 16%, respectively. The growth in database option product revenues is partly due to strong demand for our Real Application Cluster (RAC) product, which allows customers to manage their software using multiple computers, rather than mainframe computers, in a fault tolerant environment. RAC revenues grew 36% and 24% in the second quarter and on a trailing 4-quarter basis, respectively. Middleware revenues grew 6% in the second quarter and 24% on a trailing 4-quarter basis, respectively. We believe the growth in middleware revenues is due to a gain in market share in the application server market as a result of better sales execution and more competitive features and functionality.

 

Excluding the effect of currency rate fluctuations, application revenues increased 24% and 37% in the second quarter of fiscal 2006 and on a trailing 4-quarter basis, respectively. The growth in our applications sales is the result of $72 million in revenues from the licensing of PeopleSoft products, increased demand for our applications products, better sales execution as a result of segmenting our sales force by product, and a strengthening of our competitive position in the applications market, particularly in the United States.

 

New software license revenues earned from transactions over $0.5 million increased from 40% of new software license revenues in the second quarter of fiscal 2005 to 41% in the second quarter of fiscal 2006. New software license revenues earned from large contracts increased by 14% in the second quarter of fiscal 2006 from the prior year corresponding period.

 

Sales and marketing expenses increased primarily due to personnel related costs associated with increased sales headcount, higher commission expenses resulting from higher revenue levels, and higher marketing program expenses.

 

The total new software license margin as a percentage of revenues declined as expenses, including amortization of intangible assets, grew faster than revenues.

 

First Half Fiscal 2006 Compared to First Half Fiscal 2005:  New software license revenues were negatively affected by foreign currency rate fluctuations of 1 percentage point. Excluding the effect of currency rate fluctuations, the Americas contributed 71%, EMEA contributed 9% and Asia Pacific contributed 20%.

 

Excluding the effect of currency rate fluctuations, the growth in new software license revenues in the first half of fiscal 2006 is due to a 5% growth in database and middleware revenues, and a 40% increase in application revenues. Applications revenues include $121 million from the licensing of PeopleSoft products. Database revenues grew 4%, while middleware revenues grew 16%.

 

New software license revenues earned from transactions over $0.5 million increased from 35% of new software license revenues in the first half of fiscal 2005 to 36% in the first half of fiscal 2006. New software license revenues earned from large contracts increased by 14% in the first half of fiscal 2006 from the prior year corresponding period.

 

Sales and marketing expenses increased in the first half of fiscal 2006 from the prior year corresponding period primarily due to the same reasons noted above. Likewise, the total new software license margin as a percentage of revenues declined in the first half of 2006 as expenses, including amortization of intangible assets, grew at a faster rate than revenues.

 

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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,

         2005    

   Percent Change

       2004    

       2005    

   Percent Change

       2004    

(Dollars in millions)


      Actual

   Constant

         Actual

   Constant

  
Software License Updates and Product Support Revenues:                    

Americas

   $ 882    39%    38%    $ 633    $ 1,729    39%    38%    $ 1,240

EMEA

     484    8%    14%      451      951    10%    13%      863

Asia Pacific

     193    15%    19%      168      381    17%    18%      324
    

            

  

            

Total revenues

     1,559    25%    27%      1,252      3,061    26%    26%      2,427

Expenses:

                                               

Software license updates and product support (1)

     175    24%    25%      141      334    21%    21%      277

Stock-based compensation

        *    *           1    *    *     

Amortization of intangible assets (2)

     78    *    *           155    *    *     
    

            

  

            

Total expenses

     253    79%    81%      141      490    77%    77%      277
    

            

  

            

Total Margin

   $ 1,306    18%    20%    $ 1,111    $ 2,571    20%    20%    $ 2,150
    

            

  

            

Total Margin %

     84%                89%      84%                89%

% Revenues by Geography:

                                               

Americas

     57%                51%      56%                51%

EMEA

     31%                36%      31%                36%

Asia Pacific

     12%                13%      13%                13%

 


(1) Excluding stock-based compensation
(2) Included as a component of ‘Amortization of Intangible Assets’ in our condensed consolidated statements of operations
* not meaningful

 

Fiscal Second Quarter 2006 Compared to Fiscal Second Quarter 2005:  Excluding the effect of currency rate fluctuations, software license updates and product support revenues increased as a result of approximately $240 million in revenues from the expansion of our customer base resulting from the acquisition of PeopleSoft, the renewal of substantially all of the subscription base eligible for renewal in the current year, and the addition of software license updates and product support revenues associated with new software license revenues recognized over the past trailing 4-quarters. Excluding the effect of currency rate fluctuations, the Americas contributed 72% to the growth in software license updates and product support revenues, EMEA contributed 18% and Asia Pacific contributed 10%.

 

As a result of the acquisition of PeopleSoft and other businesses, we recorded adjustments to reduce support obligations assumed in business acquisitions to their estimated fair value at the acquisition dates. Due to our application of business combination accounting rules, software license updates and product support revenues related to support contracts in the amount of $102 million that would have been otherwise recorded by PeopleSoft and other acquired businesses as independent entities, were not recognized in the second quarter of fiscal 2006. Historically, substantially all of our customers, including customers from acquired companies, renew their contracts when the contract is eligible for renewal. To the extent these underlying support contracts are renewed, we will recognize the revenue for the full value of the support contracts over the support periods, the majority of which are one year.

 

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Excluding the effect of currency rate fluctuations, software license updates and product support expenses increased primarily due to personnel related costs associated with increased headcount levels to support our applications customers.

 

The software license updates and product support margin as a percentage of revenues decreased in the first quarter of fiscal 2006 from the prior year corresponding period primarily due to incremental amortization costs of intangible assets acquired in connection with the PeopleSoft acquisition.

 

First Half Fiscal 2006 Compared to First Half Fiscal 2005:  The growth in software license updates and product support revenues and expenses is attributed to the same reasons noted above. Software license updates and product support revenues includes approximately $445 million from the expansion of our customer base resulting from the acquisition of PeopleSoft in the six months ending November 30, 2005. Excluding the effect of currency rate fluctuations, the Americas contributed 73% to the growth in software license updates and product support revenues, EMEA contributed 18% and Asia Pacific contributed 9%. Software license updates and product support revenues related to support contracts in the amount of $240 million that would have been otherwise recorded by PeopleSoft and other acquired businesses as independent entities, were not recognized in the first half of fiscal 2006.

 

Services

 

Services consist of consulting, On Demand and education.

 

Consulting:  Consulting revenues are earned by providing services to customers in the design, implementation, deployment and upgrade of our database, middleware 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,

         2005    

   Percent Change

       2004    

           2005

   Percent Change

       2004    

(Dollars in millions)


      Actual

   Constant

         Actual

   Constant

  

Consulting Revenues:

                                               

Americas

   $ 270    40%    38%    $ 194    $ 540    39%    38%    $ 388

EMEA

     188    9%    16%      171      352    14%    18%      308

Asia Pacific

     48    60%    65%      30      95    75%    75%      55
    

            

  

            

Total revenues

     506    28%    31%      395      987    32%    32%      751

Expenses:

                                               

Cost of services (1)

     441    33%    35%      332      870    33%    34%      653

Stock-based compensation

     2    *    *           4    *    *     

Amortization of intangible assets (2)

     1    *    *           2    *    *     
    

            

  

            

Total expenses

     444    34%    36%      332      876    34%    35%      653
    

            

  

            

                                                 

Total Margin

   $ 62    -2%    3%    $ 63    $ 111    13%    17%    $ 98
    

            

  

            

Total Margin %

     12%                16%      11%                13%

% Revenues by Geography:

                                               

Americas

     53%                49%      55%                52%

EMEA

     37%                43%      35%                41%

Asia Pacific

     10%                8%      10%                7%

(1) Excluding stock-based compensation

(2) Included as a component of ‘Amortization of Intangible Assets’ in our condensed consolidated statements of operations

* not meaningful

 

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Fiscal Second Quarter 2006 Compared to Fiscal Second Quarter 2005:  The increase in consulting revenues is primarily due to an increase in application product implementations and billable hours, primarily provided by consultants who were formerly employed by our acquired companies. Excluding the effect of currency rate fluctuations, the Americas contributed 61% to the growth in consulting revenues, EMEA contributed 23% and Asia Pacific contributed 16%.

 

Excluding the effect of currency rate fluctuations, consulting expenses grew as a result of higher personnel related expenditures associated with increased headcount and revenue levels, as well as higher external contractor costs incurred to perform implementation services for our customers.

 

First Half Fiscal 2006 Compared to First Half Fiscal 2005:  Excluding the effect of currency rate fluctuations, the growth rates for both consulting revenues and expenses were due to the same reasons as noted above. The Americas contributed 61% to the growth in consulting revenues, EMEA contributed 22% and Asia Pacific contributed 17%.

 

On Demand:  On Demand includes Oracle On Demand and Advanced Customer Services. Oracle On Demand provides multi-featured software and hardware management and maintenance services for our database, middleware and applications software. Advanced Customer Services consists of configuration and performance analysis, personalized support and annual on-site technical services. The cost of providing On Demand services consist primarily of personnel related expenditures and hardware and facilities costs.

 

     Three Months Ended November 30,

   Six Months Ended November 30,

         2005    

   Percent Change

       2004    

       2005    

   Percent Change

       2004    

(Dollars in millions)


      Actual

   Constant

         Actual

   Constant

  

On Demand Revenues:

                                        

Americas

   $ 49    31%    30%    $ 37    $ 97    24%    23%    $ 77

EMEA

     27    11%    18%      24      52    15%    19%      45

Asia Pacific

     11    2%    3%      11      22    8%    5%      21
    

            

  

            

Total revenues

     87    20%    22%      72      171    19%    19%      143

Cost of services

     81    41%    43%      58      156    41%    41%      111
    

            

  

            

Total Margin

   $ 6    -62%    -62%    $ 14    $ 15    -54%    -54%    $ 32
    

            

  

            

Total Margin %

     6%                19%      9%                22%

% Revenues by Geography:

                                               

Americas

     57%                52%      57%                54%

EMEA

     30%                33%      30%                31%

Asia Pacific

     13%                15%      13%                15%

 

Fiscal Second Quarter 2006 Compared to Fiscal Second Quarter 2005:  Excluding the effect of currency rate fluctuations, On Demand revenues increased in the second quarter of fiscal 2006 from the prior year corresponding period due to the expansion of our subscription base in Oracle On Demand services, as well as higher revenues from Advanced Customer Services. Excluding the effect of currency rate fluctuations, the Americas contributed 71% to the increase in On Demand revenues, EMEA contributed 27% and Asia Pacific contributed 2%.

 

Excluding the effect of currency rate fluctuations, expenses increased primarily due to higher headcount levels and associated personnel related expenditures. The On Demand margin as a percent of revenues decreased as expenses grew at a higher rate than revenues to support future growth.

 

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First Half Fiscal 2006 Compared to First Half Fiscal 2005:  Excluding the effect of currency rate fluctuations, the growth rates for both On Demand revenues and expenses increased due to the same reasons as noted above. The Americas contributed 65% to the growth in On Demand revenues, EMEA contributed 31% and Asia Pacific contributed 4%.

 

Education:  Education revenues are earned by providing instructor led, media based and internet based training in the use of our database, middleware 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)


       2005    

   Actual

   Constant

       2004    

       2005    

   Actual

   Constant

       2004    

Education Revenues:

                                               

Americas

   $ 37    59%    57%    $ 23    $ 72    70%    68%    $ 42

EMEA

     32    6%    12%      31      55    9%    13%      51

Asia Pacific

     13    6%    8%      12      27    13%    12%      23
    

            

  

            

Total revenues

     82    25%    27%      66      154    32%    33%      116

Cost of services

     58    0%    0%      59      115    10%    10%      104
    

            

  

            

Total Margin

   $ 24    *    *    $ 7    $ 39    *    *    $ 12
    

            

  

            

Total Margin %

     29%                11%      25%                10%

% Revenues by Geography:

                                               

Americas

     45%                35%      47%                36%

EMEA

     39%                47%      36%                44%

Asia Pacific

     16%                18%      17%                20%

* not meaningful

 

Fiscal Second Quarter 2006 Compared to Fiscal Second Quarter 2005:  Education revenues primarily increased due to an increase in customer training on the use of our applications products. Excluding the effect of currency rate fluctuations, the Americas contributed 73%, EMEA contributed 21% and Asia Pacific contributed 6% to the overall increase in education revenues.

 

Excluding the effect of currency rate fluctuations, the increase in education expenses is due to higher headcount levels and associated personnel related expenditures. The education margin as a percentage of revenues increased as revenues increased at a higher rate than expenses.

 

First Half Fiscal 2006 Compared to First Half Fiscal 2005:  Excluding the effect of currency rate fluctuations, the growth rates for both education revenues and expenses were due to the same reasons as noted above. The Americas contributed 75% to the growth in education revenues, EMEA contributed 17% and Asia Pacific contributed 8%.

 

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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,

        2005    

  Percent Change

      2004    

      2005    

  Percent Change

      2004    

(Dollars in millions)


    Actual

  Constant

      Actual

  Constant

 

Research and development (1)

  $ 464   45%   46%   $ 320   $ 860   38%   38%   $ 623

Stock-based compensation

    4   *   *         8   *   *    

Amortization of intangible assets (2)

    3   -56%   -56%     7     8   -52%   -52%     16
   

         

 

         

Total expenses

  $ 471   44%   44%   $ 327   $ 876   37%   37%   $ 639

% of Total Revenues

    14%             12%     14%             13%

(1) Excluding stock-based compensation
(2) Included as a component of ‘Amortization of Intangible Assets’ in our condensed consolidated statements of operations
* not meaningful

 

Fiscal Second Quarter 2006 Compared to Fiscal Second Quarter 2005:  Excluding the effect of currency rate fluctuations, research and development expenses increased due to higher personnel related costs associated with increased headcount levels, costs associated with patent litigation, as well as higher external contractor costs. Total research and development headcount increased by approximately 3,300 employees or 31% over the prior year. Research and development headcount increased by 3% in the database and middleware divisions, and 57% in the applications division.

 

First Half Fiscal 2006 Compared to First Half Fiscal 2005:  Excluding the effect of currency rate fluctuations, research and development expenses increased for the same reasons noted above.

 

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

       2004    

        Percent Change

       2004    

(Dollars in millions)


       2005    

   Actual

   Constant

          2005    

   Actual

   Constant

  

General and administrative

   $ 109    -16%    -15%    $ 130    $ 265    4%    4%    $ 255

% of Total Revenues

     3%                5%      4%                5%

 

Fiscal Second Quarter 2006 Compared to Fiscal Second Quarter 2005:  General and administrative expenses decreased due to the reversal of a $24 million charge for an expected legal settlement that was accrued in the first quarter of fiscal 2006. During the second quarter, a judgment was rendered on this settlement that relieved us of this possible liability. Excluding this charge and the effect of currency rate fluctuations, general and administrative expenses would have increased 3% due to higher headcount levels and associated costs, offset by lower discretionary bonuses.

 

First Half Fiscal 2006 Compared to First Half Fiscal 2005:  Excluding the effect of currency rate fluctuations, general and administrative expenses increased due to higher headcount levels and associated costs, offset by lower discretionary bonuses.

 

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Amortization of Intangible Assets:  Amortization of intangible assets increased in the second quarter and first half of fiscal 2006 from the prior year corresponding periods primarily from purchased intangible assets associated with our acquisition of PeopleSoft.

 

     Three Months Ended
November 30,


  

Six Months Ended

November 30,


(in millions)


       2005    

       2004    

       2005    

       2004    

Software support agreements and related relationships

   $ 54    $    $ 107    $

Developed technology

     44      7      86      16

Core technology

     19           38     

Customer contracts

     6           12     

Trademarks

     3           6     
    

  

  

  

Total amortization of intangible assets

   $ 126    $ 7    $ 249    $ 16
    

  

  

  

 

Acquisition Related Charges:  Acquisition related charges primarily consist of in-process research and development expenses, integration-related professional services, stock-compensation expenses and personnel related costs for transitional employees, as well as costs associated with our tender offer for PeopleSoft prior to the agreement date. Stock-based compensation included in acquisition related charges resulted from unvested options assumed in the PeopleSoft acquisition whose vesting was fully accelerated upon termination of the employees pursuant to the terms of these options. In the second quarter and first half of fiscal 2005, acquisition related charges included costs associated with our tender offer for PeopleSoft prior to the agreement date.

 

    

Three Months Ended

November 30,


  

Six Months Ended

November 30,


(in millions)


       2005    

       2004    

       2005    

       2004    

In-process research and development

   $ 4    $    $ 12    $

Transitional employee related costs

     5           11     

Stock-based compensation

     1           4     

Professional fees

          23      11      52
    

  

  

  

Total acquisition related charges

   $ 10    $ 23    $ 38    $ 52
    

  

  

  

 

Restructuring:  Restructuring expenses consist of Oracle employee severance costs of $11 million were recorded in the first quarter of fiscal 2006. There were no restructuring charges recorded in the second quarter of fiscal 2006 or the comparable periods in fiscal 2005.

 

Interest Expense:  Interest expense increased 184% to $16 million and increased 230% to $37 million in the second quarter and first half of fiscal 2006 compared to the corresponding prior periods, respectively, due to borrowings under our commercial paper program and unsecured loan facility.

 

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Non-Operating Income, net:  Non-operating income, net consists primarily of interest income, net foreign currency exchange gains (losses), net investment gains 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)


       2005    

    Actual

  Constant

      2004    

        2005    

    Actual

  Constant

      2004    

 

Interest income

   $ 24     -43%   -43%   $ 43     $ 49     -38%   -38%   $ 80  

Foreign currency gains (losses)

     (4 )   *   *     (7 )     13     *   *     (11 )

Net investment gains related to equity securities

     3     *   *           4     *   *     1  

Minority interest

     (9 )   -7%   -7%     (10 )     (17 )   -10%   -10%     (19 )

Other

     8     *   *     3       14     *   *     7  
    


         


 


         


Total non-operating income, net

   $ 22     -25%   -22%   $ 29     $ 63     9%   11%   $ 58  
    


         


 


         



* not meaningful

 

The increase in non-operating income, net is primarily due to higher foreign currency gains partially offset by lower interest income. The increase in foreign currency gains primarily relates to the Chinese currency revaluation in July 2005. The decrease in interest income is primarily due to lower cash and short-term investment balances as a result of using available cash for the pay down of commercial paper borrowings. In the second quarter and first half of fiscal 2006, the weighted average interest rate earned on cash, cash equivalents and marketable securities increased from 1.9% to 2.3% and 1.7% to 2.2%, respectively.

 

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 indefinitely reinvested in foreign operations. Future effective tax rates could be adversely affected if earnings are lower than anticipated in countries where we have lower statutory rates, if earnings are higher than anticipated in countries where we have higher statutory rates, by unfavorable changes in tax laws and regulations or by adverse rulings in tax related litigation.

 

The provision for income taxes decreased 4% from $339 million in the second quarter of fiscal 2005 to $324 million in the second quarter of fiscal 2006 and decreased 5% from $568 million in the first half of fiscal 2005 to $538 million in the first half of fiscal 2006 due to a lower effective tax rate. The decrease in the effective tax rate from 29.4% in the second quarter of fiscal 2005 to 28.9% in the second quarter of fiscal 2006 and from 30.0% in the first half of fiscal 2005 to 29.0% in the first half of fiscal 2006 is attributable to a higher ratio of earnings from lower tax rate jurisdictions.

 

Liquidity and Capital Resources

 

(Dollars in millions)


   November 30,
2005


   Change

  

     May 31,     

2005


Working capital

   $ 703    83%    $ 385

Cash, cash equivalents and marketable securities

   $ 3,403    -29%    $ 4,771

 

Working capital:  The increase in working capital as of November 30, 2005 is primarily due to greater cash flows from operations from higher sales volumes, partially offset by cash used to pay for acquisitions and to reduce debt obligations.

 

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Cash, cash equivalents and marketable securities:  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. Marketable securities primarily consist of commercial paper, corporate notes and Unites States government agency notes. Cash, cash equivalents and marketable securities include $3.0 billion held by our foreign subsidiaries as of November 30, 2005. The decrease in cash, cash equivalents and marketable securities is due to the use of available cash to repay certain debt obligations and fund acquisitions.

 

     Six Months Ended November 30,

 

(Dollars in millions)


       2005    

     Change 

       2004    

 

Cash provided by operating activities

   $ 1,756     -2%    $ 1,799  

Cash (used for) provided by investing activities

   $ (826 )   -201%    $ 818  

Cash used for financing activities

   $ (1,905 )   99%    $ (956 )

 

Cash flows from 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. We also 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 decreased in the first half of fiscal 2006 primarily due to increased income taxes paid attributable to the repatriation of the maximum dividend available under the American Jobs Creation Act of 2004 and the timing of tax payments as a result of acquisitions, partially offset by higher net income, excluding non-cash charges and increases in non-acquisition related deferred revenues.

 

Days sales outstanding, which is calculated by dividing period end accounts receivable by average daily sales for the quarter, was 52 at November 30, 2005 and 56 days at May 31, 2005. The days sales outstanding calculation excludes the adjustment to reduce software license updates and product support revenue related to adjusting the carrying value for deferred support revenues acquired, primarily from PeopleSoft, to its estimated fair value. The decline in days sales outstanding is due to more timely collections, as well as a shift in the mix of total revenues. Software license updates and product support revenues are generally billed one year in advance, while the revenues are recognized ratably over the annual contract period. Software license updates and product support revenues as a percentage of total revenues increased, resulting in higher cash collections and lower days sales outstanding.

 

Cash flows from investing activities: The changes in cash flows from investing activities primarily relate to acquisitions and the timing of purchases and maturities of marketable securities. We also use cash to invest in capital and other assets to support our growth.

 

Cash used for investing activities was attributable to cash used for our acquisitions in the first half of fiscal 2006, including our equity investment in i-flex, while net cash provided by investing activities in the first half of fiscal 2005 was attributable to net investment proceeds received.

 

Cash flows from financing activities: The changes in cash flows from financing activities primarily relate to payments made for stock repurchases, as well as borrowings and payments under debt obligations.

 

Net cash used for financing activities increased in the first half of fiscal 2006 primarily due to net repayment of amounts under our commercial paper program, partially offset by higher stock repurchases in the first half of fiscal 2005.

 

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Free cash flow: To supplement our statements of cash flows presented on a GAAP basis, we use non-GAAP measures of cash flows on a trailing 4-quarter basis to analyze cash flow generated from operations. We believe free cash flow is also useful as one of the bases for comparing our performance with our competitors. The presentation of non-GAAP free cash flow is not meant to 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 4-Quarters Ended
November 30,


 

(Dollars in millions)


       2005    

     Change 

       2004    

 

Cash provided by operating activities

   $ 3,509     4%    $ 3,386  

Capital expenditures (1)

   $ (182 )   2%    $ (178 )
    


      


Free cash flow

   $ 3,327     4%    $ 3,208  
    


      


Net income

   $ 2,878          $ 2,948  

Free cash flow as a percent of net income

     116%            109%  

(1) Represents capital expenditures as reported in cash flows from investing activities in our condensed consolidated statements of cash flows 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, 2005 and 2004, $158.1 million and $163.1 million or approximately 9% and 11% of our new software license revenues were financed through our financing division.

 

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Contractual Obligations

 

The contractual obligations presented in the table below represent our estimates of future payments under fixed contractual obligations and commitments. Changes in our business needs, cancellation provisions, changing interest rates and other factors may result in actual payments differing from these estimates. We cannot provide certainty regarding the timing and amounts of payments. We have presented below a summary of the most significant assumptions used in our information within the context of our consolidated financial position, results of operations and cash flows. The following is a summary of our contractual obligations as of November 30, 2005:

 

     Year Ending May 31,

(in millions)


   Total

       2006    

       2007    

       2008    

       2009    

       2010    

       2011    

   Thereafter

Balance Sheet Contractual Obligations:

                                                       

Short-term borrowings (1)

   $ 907    $ 907    $    $    $    $    $    $

Principal payments on senior notes

     150           150                         

Payable to PeopleSoft stockholders (2)

     4      4                              

Notes payable

     6           6                         
    

  

  

  

  

  

  

  

Total balance sheet contractual obligations

     1,067      911      156                         

Other Contractual Obligations:

                                                       

Interest payments on short-term borrowings (1)

     10      10                              

Interest payments on senior notes (3)

     12      5      7                         

Operating leases (4)

     806      103      177      138      114      89      56      129

Purchase obligations (5)

     48      20      18      9      1               

Funding commitments (6)

     8      8                              
    

  

  

  

  

  

  

  

Total other contractual obligations

     884      146      202      147      115      89      56      129
    

  

  

  

  

  

  

  

Total contractual obligations

   $ 1,951    $ 1,057    $ 358    $ 147    $ 115    $ 89    $ 56    $ 129
    

  

  

  

  

  

  

  


(1) Short-term borrowings include approximately $489 million in promissory notes under our commercial paper program with various maturities through December 2005, net of unamortized discount of $1 million (weighted average effective interest rate of 4.13% at November 30, 2005) and $418 million outstanding under our unsecured $700 million loan facility due May 2006 (effective interest rate of 4.47% at November 30, 2005).
(2) On January 7, 2005, we completed the merger of PeopleSoft and converted each remaining outstanding share of PeopleSoft common stock not tendered into a right to receive $26.50 per share in cash, without interest. As of November 30, 2005, $4.0 million remained payable to PeopleSoft stockholders who had not submitted their shares.
(3) Represents estimated interest payments on our senior notes using an effective interest rate of 6.43% at November 30, 2005. 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.
(4) Includes future minimum rent payments for facilities that we have vacated pursuant to our restructuring and merger integration activities. We have approximately $123 million in facility obligations, net of estimated sublease income and other costs, in accrued restructuring for these locations in our condensed consolidated balance sheet at November 30, 2005.
(5) 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.
(6) Funding commitments relate to the maximum additional capital we may need to contribute toward our venture fund investments which are payable upon demand.

 

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Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

 

Pending Acquisition of Siebel Systems, Inc.

 

On September 12, 2005, we entered into a Merger Agreement to acquire Siebel Systems, Inc. The proposed transaction is valued at approximately $6.1 billion. The transaction is conditioned upon (i) clearance under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, which occurred on November 15, 2005, and the applicable foreign antitrust laws of certain other jurisdictions, including the European Commission, which occurred on December 22, 2005, (ii) approval of the merger and adoption of the Merger Agreement by Siebel stockholders and (iii) other customary closing conditions. We expect that the transaction will close on January 31, 2006, or shortly thereafter, provided the foregoing conditions which have not yet been satisfied or waived are satisfied or waived.

 

Pursuant to the Merger Agreement, each share of Siebel common stock will be converted into the right to receive either (a) $10.66 in cash or (b) a number of shares of our common stock equal to $10.66 divided by the greater of (i) $10.72 or (ii) the average closing price of our common stock over the ten trading days immediately preceding (but not including) the closing date, provided that no more than 30% of the outstanding Siebel common stock may be converted into our common stock. If Siebel stockholders holding more than 30% of Siebel common stock elect to receive our stock, the equity consideration will be prorated. The stock election will not be available unless the holders of at least 6% of the outstanding Siebel common stock make the stock election. In addition, options to acquire Siebel common stock and Siebel restricted stock awards will be converted into options to acquire shares of our common stock based on formulas contained in the Merger Agreement.

 

We expect that we will borrow $5.0 billion to finance the Siebel Systems, Inc. acquisition and for acquisition-related transaction costs, and depending on how much stock is issued, to use any remaining proceeds for general corporate purposes.

 

We believe that our current cash and cash equivalents, marketable securities and cash generated from operations will be sufficient to meet our working capital, capital expenditure, contractual obligations and investment needs. In addition, we believe we could fund other acquisitions, including our pending acquisitions, with our internally available cash and investments, cash generated from operations, amounts available under our commercial paper program, additional borrowings 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 2.0% and has averaged 1.1% 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, 2005, 22% 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, however, we may reduce the level of our stock repurchases in the future as we may use our available cash to repay indebtedness. At November 30, 2005, 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 9.3%.

 

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The Compensation Committee 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 grants 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.

 

Options granted from June 1, 2002 through November 30, 2005 are summarized as follows:

 

    

(Shares

in millions)


 

Options outstanding at May 31, 2002

   454  

Options granted (1)

   313  

Options exercised

   (187 )

Forfeitures

   (99 )
    

Options outstanding at November 30, 2005

   481  
    

Average annualized options granted, net of forfeitures

   61  

Average annualized stock repurchases