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 February 28, 2006

 

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: 000-51788

 


 

Oracle Corporation

(Exact name of registrant as specified in its charter)

 

Delaware   54-2185193
(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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated filer    x            Accelerated filer    ¨            Non-accelerated filer    ¨    

 

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 April 3, 2006 was: 5,334,663,163.

 




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 February 28, 2006 and May 31, 2005    1
     Condensed Consolidated Statements of Operations for the Three and Nine Months Ended February 28, 2006 and 2005    2
     Condensed Consolidated Statements of Cash Flows for the Nine Months Ended February 28, 2006 and 2005    3
     Notes to Condensed Consolidated Financial Statements    4

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    25

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk    62

Item 4.

   Controls and Procedures    64

PART II.  OTHER INFORMATION

    

Item 1.

   Legal Proceedings    65

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds    65

Item 6.

   Exhibits    65
     Signatures    67


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item  1. Financial Statements

 

ORACLE CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

As of February 28, 2006 and May 31, 2005

(Unaudited)

 

(in millions, except per share data)


   February 28,
2006


    May 31,
2005


 

ASSETS

                

Current assets:

                

Cash and cash equivalents

   $ 6,921     $ 3,894  

Marketable securities

     843       877  

Trade receivables, net of allowances of $307 and $269

     2,201       2,570  

Other receivables

     264       330  

Deferred tax assets

     738       486  

Prepaid expenses and other current assets

     232       291  
    


 


Total current assets

     11,199       8,448  
    


 


Non-current assets:

                

Property, net

     1,375       1,442  

Intangible assets, net

     4,703       3,373  

Goodwill

     10,075       7,003  

Deferred tax assets

     40       32  

Other assets

     1,072       389  
    


 


Total non-current assets

     17,265       12,239  
    


 


Total assets

   $ 28,464     $ 20,687  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY

                

Current liabilities:

                

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

   $ 341     $ 2,693  

Accounts payable

     233       230  

Income taxes payable

     678       904  

Accrued compensation and related benefits

     858       923  

Accrued restructuring

     247       156  

Deferred revenues

     2,467       2,289  

Other current liabilities

     1,042       868  
    


 


Total current liabilities

     5,866       8,063  
    


 


Non-current liabilities:

                

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

     5,741       159  

Deferred tax liabilities

     799       1,010  

Accrued restructuring

     521       120  

Deferred revenues

     111       126  

Other long-term liabilities

     383       372  
    


 


Total non-current liabilities

     7,555       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: 5,312 shares at February 28, 2006 and 5,145 shares at May 31, 2005

     9,038       6,596  

Retained earnings

     5,828       4,043  

Deferred compensation

     (42 )     (45 )

Accumulated other comprehensive income

     219       243  
    


 


Total stockholders’ equity

     15,043       10,837  
    


 


Total liabilities and stockholders’ equity

   $ 28,464     $ 20,687  
    


 


 

See notes to condensed consolidated financial statements.

 

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Table of Contents

ORACLE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

For the Three and Nine Months Ended February 28, 2006 and 2005

(Unaudited)

 

     Three Months Ended
February 28,


     Nine Months Ended
February 28,


 

(in millions, except per share data)


   2006

       2005

     2006

       2005

 

Revenues:

                                       

New software licenses

   $ 1,096        $ 947      $ 2,783        $ 2,481  

Software license updates and product support

     1,703          1,389        4,764          3,816  
    


    


  


    


Software revenues

     2,799          2,336        7,547          6,297  

Services

     671          614        1,982          1,624  
    


    


  


    


Total revenues

     3,470          2,950        9,529          7,921  
    


    


  


    


Operating expenses:

                                       

Sales and marketing

     756          668        2,076          1,703  

Software license updates and product support

     178          161        514          438  

Cost of services

     612          555        1,757          1,423  

Research and development

     467          411        1,335          1,034  

General and administrative

     146          146        410          401  

Amortization of intangible assets

     148          81        398          97  

Acquisition related

     84          51        122          103  

Restructuring

     27          107        38          107  
    


    


  


    


Total operating expenses

     2,418          2,180        6,650          5,306  
    


    


  


    


Operating income

     1,052          770        2,879          2,615  

Interest expense

     (49 )        (58 )      (86 )        (69 )

Non-operating income, net

     75          59        138          117  
    


    


  


    


Income before provision for income taxes

     1,078          771        2,931          2,663  

Provision for income taxes

     313          231        850          799  
    


    


  


    


Net income

   $ 765        $ 540      $ 2,081        $ 1,864  
    


    


  


    


Earnings per share:

                                       

Basic

   $ 0.15        $ 0.11      $ 0.40        $ 0.36  
    


    


  


    


Diluted

   $ 0.14        $ 0.10      $ 0.40        $ 0.36  
    


    


  


    


Weighted-average common shares outstanding:

                                       

Basic

     5,207          5,122        5,169          5,133  
    


    


  


    


Diluted

     5,304          5,230        5,262          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 Nine Months Ended February 28, 2006 and 2005

(Unaudited)

 

     Nine Months Ended
February 28,


 

(in millions)


       2006    

        2005    

 

Cash Flows From Operating Activities:

                

Net income

   $ 2,081     $ 1,864  

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

                

Depreciation

     160       142  

Amortization of intangible assets

     398       97  

Deferred income taxes

     (115 )     (117 )

Minority interests in income

     27       27  

Amortization of stock-based compensation

     33       11  

Non-cash restructuring

           33  

In-process research and development

     86       33  

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

                

Decrease in trade receivables

     670       824  

Decrease in prepaid expenses and other assets

     123       195  

Decrease in accounts payable and other liabilities

     (382 )     (455 )

Decrease in income taxes payable

     (201 )     (121 )

(Decrease) increase in deferred revenues

     (18 )     24  
    


 


Net cash provided by operating activities

     2,862       2,557  
    


 


Cash Flows From Investing Activities:

                

Purchases of marketable securities

     (1,473 )     (6,545 )

Proceeds from maturities and sale of marketable securities

     3,083       10,537  

Acquisitions, net of cash acquired

     (3,932 )     (9,892 )

Purchase of equity investment

     (605 )      

Capital expenditures

     (161 )     (150 )

Proceeds from sale of property

     140        

Increase in other assets

     (4 )     (5 )
    


 


Net cash used for investing activities

     (2,952 )     (6,055 )
    


 


Cash Flows From Financing Activities:

                

Payments for repurchase of common stock

     (324 )     (1,095 )

Proceeds from issuance of common stock

     333       360  

Proceeds from borrowings, net of financing costs

     12,636       9,200  

Payments of debt

     (9,446 )     (2,000 )

Distributions to minority interests

     (39 )     (44 )
    


 


Net cash provided by financing activities

     3,160       6,421  
    


 


Effect of exchange rate changes on cash and cash equivalents

     (43 )     160  
    


 


Net increase in cash and cash equivalents

     3,027       3,083  

Cash and cash equivalents at beginning of period

     3,894       4,138  
    


 


Cash and cash equivalents at end of period

   $ 6,921     $ 7,221  
    


 


Non-cash financing transactions:

                

Fair value of options and stock issued in connection with acquisitions

   $ 2,058     $ 504  

 

See notes to condensed consolidated financial statements.

 

3


Table of Contents

ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

February 28, 2006

(Unaudited)

 

1. BASIS OF PRESENTATION

 

Oracle Corporation is a holding corporation with no business operations and no significant assets other than ownership of its direct and indirect subsidiaries, which include Oracle Systems Corporation (Old Oracle), Siebel Systems, Inc. (Siebel) and each of their domestic and foreign subsidiaries around the world. Oracle Corporation, or Oracle, was initially formed as a direct wholly owned subsidiary of Old Oracle. Prior to January 31, 2006, Oracle’s name was Ozark Holding Inc. and Old Oracle’s name was Oracle Corporation. On January 31, 2006, in connection with the acquisition of Siebel, which is described in Note 3, a wholly owned subsidiary of Oracle was merged with and into Old Oracle, with Old Oracle surviving as a wholly owned subsidiary of Oracle (the Reorganization). In addition, another wholly owned subsidiary of Oracle was merged with and into Siebel, with Siebel surviving as a wholly owned subsidiary of Oracle. As a result, Oracle became the parent company of Old Oracle and Siebel, and the changes to the names of Oracle and Old Oracle were effected.

 

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 the Annual Report on Form 10-K, as amended, of Old Oracle (SEC File No. 000-14376) 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. Additionally, there have been no significant changes in new accounting pronouncements disclosed in our Form 10-K, as amended, except for an update to the estimated impact of adopting FASB Statement No. 123 (revised 2004), Share-Based Payment, as discussed in Note 2.

 

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:

 

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Table of Contents

ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2006

(Unaudited)

 

     Three Months Ended
February 28,


   

Nine Months Ended

February 28,


 

(in millions, except per share data)


       2006    

        2005    

        2006    

        2005    

 

Net income, as reported

   $ 765     $ 540     $ 2,081     $ 1,864  

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

     10       30       24       30  

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

     (41 )     (42 )     (114 )     (121 )
    


 


 


 


Pro forma net income

   $ 734     $ 528     $ 1,991     $ 1,773  
    


 


 


 


Earnings per share:

                                

Basic—as reported

   $ 0.15     $ 0.11     $ 0.40     $ 0.36  

Basic—pro forma

   $ 0.14     $ 0.10     $ 0.39     $ 0.35  

Diluted—as reported

   $ 0.14     $ 0.10     $ 0.40     $ 0.36  

Diluted—pro forma

   $ 0.14     $ 0.10     $ 0.38     $ 0.34  

(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 and $33 in the three and nine months ended February 28, 2006 and $14 and $22 for the three and nine months ended February 28, 2005.

 

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, including options issued or assumed from acquisitions, were estimated at the date of grant using the following weighted-average assumptions:

 

     Three Months Ended
February 28,


    Nine Months Ended
February 28,


 

   2006

    2005

    2006

    2005

 

Expected life (in years)

     0.25-7.23       0.25-5.41       0.25-7.5       0.25-6.54  

Risk-free interest rate

     4.45-4.61 %     2.5-4.05 %     3.38-4.61 %     2.40-4.05 %

Volatility

     24-27 %     30-32 %     24-28 %     30-36 %

Dividend yield

                        

Weighted-average fair value of grants

   $ 3.18     $ 5.07     $ 3.88     $ 4.73  

 

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Table of Contents

ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2006

(Unaudited)

 

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%. The fair value of the option component of the employee purchase plan shares purchased prior to April 2005 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 months ended February 28, 2005, respectively: expected life of 0.50 years, risk-free interest rate of 2.92%, volatility of 32% and dividend yield of 0%. The weighted average fair value of employee purchase plan grants was $2.76 for the three months ended February 28, 2005. The following weighted-average assumptions were used in the nine months ended February 28, 2005, respectively: expected life of 0.50 years, risk-free interest rate of 1.69-2.92%, volatility of 32-37% and dividend yield of 0%. The weighted average fair value of employee purchase plan grants was $2.98 for the nine months ended February 28, 2005.

 

We are required to adopt the provisions of Statement 123(R) in fiscal 2007, with early-adoption permitted. 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 operating expenses, 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. We currently estimate that the adoption of Statement 123(R) will increase operating expenses by $250 to $300 million on an annual basis.

 

3. ACQUISITIONS

 

Fiscal 2006 Acquisitions

 

Siebel Systems, Inc.

 

On January 31, 2006 (Acquisition Date), we completed our acquisition of Siebel pursuant to our Merger Agreement dated September 12, 2005. We acquired Siebel to expand our presence in the customer relationship management (CRM) applications software market. Siebel’s results of operations are included in our consolidated statements of operations from the Acquisition Date. The total preliminary purchase price is $6.1 billion and is comprised of:

 


   (in millions)

Acquisition of the 546 million shares of outstanding common stock of Siebel at $10.66 per share:

      

In cash (382 million shares)

   $ 4,073

In exchange for Oracle stock (164 million Siebel shares converted to 141 million Oracle shares)

     1,763

Fair value of Siebel stock options assumed and restricted stock awards exchanged

     262

Acquisition related transaction costs

     51
    

Total preliminary purchase price

   $ 6,149
    

 

Acquisition of common stock: Pursuant to the Merger Agreement, each share of Siebel common stock was converted into the right to receive either (a) $10.66 in cash or (b) a number of shares of Oracle common stock equal to the number of Siebel shares of common stock multiplied by 0.8593, which is $10.66 divided by the average closing price of Oracle Common Stock on the Nasdaq Stock Market over the ten trading days immediately preceding (but not including) the Acquisition Date (Average Oracle Stock Price). Since 32.68% of Siebel stockholders elected to receive Oracle common stock, the consideration was prorated, in accordance with the Merger Agreement, whereby Siebel stockholders electing stock received approximately $156 million in cash and 141 million Oracle shares of common stock (or approximately $0.8752 in cash and 0.7888 shares of Oracle

 

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Table of Contents

ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2006

(Unaudited)

 

common stock for each Siebel share). The fair value of stock issued was determined using an average price of $12.53, which represented the average closing price of our common stock for the three trading days up to and including the Acquisition Date.

 

Fair value of estimated options assumed and restricted stock awards exchanged: As of January 31, 2006, Siebel had approximately 80 million stock options and restricted stock awards outstanding. In accordance with the Merger Agreement, the conversion value of each option assumed was based on the exercise price of each Siebel option multiplied by the conversion ratio of 0.8576, which was the closing sale price of a share of Siebel common stock on January 30, 2006 divided by the Average Oracle Stock Price. The preliminary fair value of options assumed and awards exchanged was determined using an average price of $12.53 and calculated using a Black-Scholes-Merton valuation model with the following assumptions: expected life of 0.25 to 7.23 years, risk-free interest rate of 4.45 – 4.59%, expected volatility of 24% and no dividend yield. The portion of the estimated intrinsic value of unvested Siebel options and restricted stock awards related to future service has been allocated to deferred stock-based compensation and is being amortized using the accelerated expense attribution method over the remaining vesting period.

 

Acquisition related transaction costs: Acquisition related transaction costs include estimated investment banking fees, legal and accounting fees and other external costs directly related to the acquisition.

 

Preliminary Purchase Price Allocation

 

Under business combination accounting, the total preliminary purchase price was allocated to Siebel’s net tangible and identifiable intangible assets based on their estimated fair values as of January 31, 2006 as set forth below. The excess of the purchase price over the net tangible and identifiable intangible assets was recorded as goodwill. The preliminary allocation of the purchase price was based upon a preliminary 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 the valuation of identifiable intangible assets, deferred support revenues and consulting contract obligations assumed; restructuring costs; certain legal matters; income and non-income based taxes and residual goodwill. In addition, upon the finalization of the combined company’s legal entity structure, additional adjustments to deferred taxes may be required.

 


   (in millions)

 

Cash and marketable securities

   $ 2,362  

Trade receivables

     318  

Goodwill

     2,523  

Intangible assets

     1,556  

Deferred tax assets, net

     298  

Other assets

     129  

Accounts payable and other liabilities

     (291 )

Restructuring (see Note 4)

     (643 )

Deferred revenues

     (202 )

Deferred stock-based compensation

     27  

In-process research and development

     72  
    


Total preliminary purchase price

   $ 6,149  
    


 

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Table of Contents

ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2006

(Unaudited)

 

Intangible Assets

 

In performing our preliminary purchase price allocation, we considered, among other factors, our intention for future use of acquired assets, analyses of historical financial performance and estimates of future performance of Siebel’s products. The preliminary fair value of intangible assets was based, in part, on a valuation completed by Duff & Phelps, LLC using an income approach and estimates and assumptions provided by management. The rates utilized to discount net cash flows to their present values were based on our weighted average cost of capital and ranged from 10% to 18%. These discount rates were determined after consideration of our rate of return on debt capital and equity and the weighted average return on invested capital. The following table sets forth the components of intangible assets associated with the acquisition at February 28, 2006:

 

(Dollars in millions)


   Preliminary
Fair Value


   Accumulated
Amortization


    Net Book
Value


   Useful Life

Software support agreements and related relationships

   $ 820    $ (8 )   $ 812    10 years

Developed technology

     401      (7 )     394    5 years

Core technology

     198      (3 )     195    5 years

Customer relationships

     108      (1 )     107    10 years

Trademarks

     29            29    5 years
    

  


 

    

Total intangible assets

   $ 1,556    $ (19 )   $ 1,537     
    

  


 

    

 

Developed technology, which comprises products that have reached technological feasibility, includes products in most of Siebel’s product lines, principally the Siebel CRM and Siebel Business Analytics products. Core technology represents a combination of Siebel processes, patents and trade secrets related to the design and development of its applications products. This proprietary know-how can be leveraged to develop new technology and improve Oracle’s software products. Customer relationships and software support agreements and related relationships represent the underlying relationships and agreements with customers of Siebel’s installed base.

 

In-Process Research and Development

 

We expense in-process research and development (IPR&D) upon acquisition as it represents incomplete Siebel research and development projects that had not reached technological feasibility and had no alternative future use as of the Acquisition Date. Technological feasibility is established when an enterprise has completed all planning, designing, coding, and testing activities that are necessary to establish that a product can be produced to meet its design specifications including functions, features, and technical performance requirements. The value assigned to IPR&D of $72 million was determined by considering the importance of each project to our overall development plan, estimating costs to develop the purchased IPR&D into commercially viable products, estimating the resulting net cash flows from the projects when completed and discounting the net cash flows to their present value based on the percentage of completion of the IPR&D projects. Purchased IPR&D relates primarily to projects associated with the Siebel CRM and Siebel Business Analytics products that had not yet reached technological feasibility as of the Acquisition Date and have no alternative future use.

 

Deferred Revenues

 

In connection with the preliminary purchase price allocation, we have estimated the fair value of the support obligations assumed from Siebel in connection with the acquisition. We based our determination of the fair value of the support obligations using estimates and assumptions provided by management. The estimated fair value of

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2006

(Unaudited)

 

the support obligations was determined utilizing 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. The estimated costs to fulfill the support obligations were based on the historical direct costs related to providing the support services and to correct any errors in Siebel software products. We did 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 Siebel had concluded the selling effort on the support contracts prior to the Acquisition Date. The estimated research and development costs have not been included in the fair value determination, as these costs were not deemed to represent a legal obligation at the time of acquisition. We estimated the normal profit margin to be 30%. As a result, in allocating the preliminary purchase price, we recorded an adjustment to reduce the carrying value of Siebel’s January 31, 2006 deferred support revenue by $193 million to $129 million, which represents our estimate of the fair value of the support obligation assumed.

 

Pre-Acquisition Contingencies

 

We have currently not identified any material pre-acquisition contingencies where a liability is probable and the amount of the liability can be reasonably estimated. If information becomes available to us prior to the end of the purchase price allocation period, which would indicate that it is probable that such contingencies had existed and the amounts can be reasonably estimated, such items will be included in the purchase price allocation.

 

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 $608 million as of February 28, 2006, 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 in our condensed consolidated statements of operations. 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 reflected our equity in earnings of i-flex for its quarter ending December 31, 2005 of $3 million in our results of operations for the three months ended February 28, 2006. Our investment in i-flex reflects the price paid for the common stock as well as equity in earnings, and it exceeds our share of the underlying interest in the net assets of i-flex, as determined under 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 $782 million at February 28, 2006, was in excess of the carrying value of our investment of $608 million, which is recorded in other assets, net in the condensed consolidated balance sheets.

 

In March 2006, we purchased an additional 3.8 million shares of i-flex common stock through ordinary brokerage transactions at prevailing market prices on various dates for approximately $117 million, or a weighted average price of 1,376 Indian rupees per share. As a result of these purchases, we increased our equity position in i-flex to approximately 48%.

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2006

(Unaudited)

 

Other Acquisitions

 

During the first nine months of fiscal 2006, we acquired several software companies and purchased certain technology and development organizations for approximately $672 million, which includes cash paid of $638 million and the fair value of options assumed of $34 million.

 

We recorded approximately $473 million of goodwill, $170 million of identifiable intangible assets, $15 million of net tangible assets and $14 million of IPR&D in connection with these other acquisitions during the first nine months of fiscal 2006. We have included the effects of these transactions in our results of operations prospectively from the respective dates of the acquisitions.

 

Fiscal 2005 Acquisitions

 

PeopleSoft, Inc.

 

We acquired approximately 75% and 97% of the outstanding common stock of PeopleSoft, Inc. 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 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. We increased goodwill by approximately $87 million in the quarter ending February 28, 2006 to record certain pre-merger contingencies which were deemed to be probable and where the liabilities could be reasonably estimated.

 

The total purchase price was $11.1 billion, which consisted of $10,576 million in cash paid 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 $6,567 million of goodwill, $3,384 million of identifiable intangible assets, $1,096 million of net tangible assets and $33 million of in-process research and development.

 

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 $428 million of goodwill, $133 million of identifiable intangible assets, $133 million of net tangible assets and $7 million of in-process research and development. The preliminary allocation of the 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

 

The unaudited financial information in the table below summarizes the combined results of operations of Oracle, PeopleSoft and Siebel, on a pro forma basis, as though the companies had been combined as of the beginning of each of the periods presented. Pro forma financial information for our other acquisitions have not been presented, as the effects were not material to our historical consolidated financial statements either individually or in

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2006

(Unaudited)

 

aggregate. 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 acquisitions and $5.75 billion senior notes issued (see Note 6) had taken place at the beginning of each of the periods presented. The pro forma financial information for all periods presented also includes the business combination accounting effect on historical PeopleSoft and Siebel support revenues, the charge for IPR&D, amortization charges from acquired intangible assets, stock-based compensation charges for unvested options assumed, Oracle restructuring costs, adjustments to interest expense and related tax effects.

 

The unaudited pro forma financial information for the three months ended February 28, 2006 combines the historical results of Oracle for the three months ended February 28, 2006 and, due to differences in our reporting periods, the historical results of Siebel from November 1, 2005 to December 31, 2005. The unaudited pro forma financial information for the nine months ended February 28, 2006 combines the historical results of Oracle for the nine months ended February 28, 2006 and the historical results of Siebel for the eight months ended December 31, 2005. The unaudited pro forma financial information for the three and nine months ended February 28, 2005 combines the historical results for Oracle for those periods, with the historical results of Siebel for the three and nine months ended December 31, 2004 and the historical results of PeopleSoft for the one and seven months ended December 28, 2004, respectively.

 

    

Three Months Ended

February 28,


  

Nine Months Ended

February 28,


(in millions, except per share data)


       2006    

       2005    

       2006    

       2005    

Total revenues

   $ 3,738    $ 3,654    $ 10,364    $ 10,256

Net income

   $ 747    $ 214    $ 1,870    $ 1,003

Basic net income per share

   $ 0.14    $ 0.04    $ 0.35    $ 0.19

Diluted net income per share

   $ 0.14    $ 0.04    $ 0.35    $ 0.19

 

4. RESTRUCTURING ACTIVITIES

 

Fiscal 2006 Restructuring Plans

 

During the third quarter of fiscal 2006, management approved and initiated plans to restructure certain operations of Oracle and pre-merger Siebel to eliminate redundant costs resulting from the acquisition of Siebel and improve efficiencies in operations. The cash restructuring charges recorded are based on restructuring plans that have been committed to by management. We expect to complete the substantial majority of our planned legal-entity mergers, information system conversions and integration of Siebel’s operations in the fourth quarter of fiscal 2006 and expect to finalize all other planned integration activities in the next six months.

 

The total estimated severance costs associated with the Fiscal 2006 Oracle Restructuring Plan are $95 million. We have incurred $27 million in restructuring expenses to date and expect to incur the remaining $68 million in the next nine months. Changes to the estimates of executing the Fiscal 2006 Oracle Restructuring Plan will be reflected in our future results of operations.

 

The total estimated restructuring costs associated with exiting activities of Siebel to approximate $643 million, consisting primarily of excess facilities obligations through fiscal 2022 as well as severance and other restructuring costs. These costs were recognized as a liability assumed in the purchase business combination and included in the allocation of the cost to acquire Siebel, and, accordingly, have resulted in an increase to goodwill. Estimated restructuring expenses may change as management executes the approved plan. Decreases to the estimates of executing the Siebel restructuring plan 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.

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2006

(Unaudited)

 

Fiscal 2005 Restructuring Plans

 

During the third quarter of fiscal 2005, management approved and initiated plans to restructure the operations of Oracle, PeopleSoft and Retek. We have completed our planned legal-entity mergers, information system conversions and integration of PeopleSoft’s and Retek’s operations as well as all Oracle exit activities. Total estimated restructuring costs associated with the Fiscal 2005 Oracle Restructuring Plan are $158 million. We estimate total restructuring costs associated with exiting activities of PeopleSoft and Retek to approximate $399 million, consisting primarily of employee severance costs as well as excess facilities obligations through fiscal 2013 and other restructuring costs.

 

Summary of All Plans

 

    Accrued
May 31,
2005


  Nine Months Ended February 28, 2006

    Accrued
Feb 28,
2006 (6)


  Total
Costs
Accrued
to Date


  Total
Expected
Program
Costs


(in millions)


    Initial
Costs


  Adj. to
Cost (4)


    Cash
Payments


    Other (5)

       

Fiscal 2006 Oracle Restructuring Plan

                                                     

New software licenses

  $   $ 3   $     $ (1 )   $     $ 2   $ 3   $ 39

Software license updates and product support

        1           (1 )               1     3

Consulting

        1                       1     1     18

On Demand (1)

        2           (2 )               2     3

Education

                                      3

Other (2)

        20           (10 )           10     20     29
   

 

 


 


 


 

 

 

Total Fiscal 2006 Oracle Restructuring

  $   $ 27   $     $ (14 )   $     $ 13   $ 27   $ 95
   

 

 


 


 


 

 

 

Fiscal 2005 Oracle Restructuring Plan

                                                     

New software licenses

  $ 14   $ 4   $ (2 )   $ (13 )   $     $ 3   $ 37   $ 37

Software license updates and product support

    1               (1 )               6     6

Consulting

    6     1     (1 )     (5 )           1     20     20

On Demand (1)

                                  2     2

Education

    2     3           (4 )           1     6     6

Other (2)

    6     7     (1 )     (8 )     (1 )     3     66     66
   

 

 


 


 


 

 

 

Total severance

    29     15     (4 )     (31 )     (1 )     8     137     137
   

 

 


 


 


 

 

 

Total facilities (3)

    21               (3 )           18     21     21
   

 

 


 


 


 

 

 

Total Fiscal 2005 Oracle Restructuring

  $ 50   $ 15   $ (4 )   $ (34 )   $ (1 )   $ 26   $ 158   $ 158
   

 

 


 


 


 

 

 

Siebel Restructuring Plan

                                                     

Severance

  $   $ 65   $     $ (24 )   $     $ 41   $ 65   $ 65

Facilities

        542           (6 )           536     542     542

Contracts and other

        36                       36     36     36
   

 

 


 


 


 

 

 

Total Siebel Restructuring

  $   $ 643   $     $ (30 )   $     $ 613   $ 643   $ 643
   

 

 


 


 


 

 

 

PeopleSoft and Retek Restructuring Plan

                                                     

Severance

  $ 63   $   $ (19 )   $ (38 )   $ (1 )   $ 5   $ 192   $ 192

Facilities

    143         2       (45 )     (2 )     98     161     161

Contracts and other

    20         7       (14 )           13     46     46
   

 

 


 


 


 

 

 

Total PeopleSoft and Retek Restructuring

  $ 226   $   $ (10 )   $ (97 )   $ (3 )   $ 116   $ 399   $ 399
   

 

 


 


 


 

 

 

Total All Restructuring Plans

  $ 276   $ 685   $ (14 )   $ (175 )   $ (4 )   $ 768            
   

 

 


 


 


 

           

(1) Formerly referred to as advanced product services.
(2) Other includes costs associated with research and development, general and administrative and marketing functions.
(3) Allocation of facility costs to operating lines of businesses and other functions was approximately $5 and $16, respectively.
(4) Primarily relates to changes in estimates related to severance payments, facility plans and other restructuring obligations relating to the PeopleSoft acquisition.
(5) Represents translation adjustments.
(6) Accrued restructuring of $768 at February 28, 2006 includes $247 recorded in accrued restructuring, current and $521, 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)

February 28, 2006

(Unaudited)

 

5. 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 from acquisitions whose vesting was fully accelerated upon termination of the employees pursuant to the terms of these options.

 

       Three Months Ended
February 28,


    

Nine Months Ended

February 28,


(in millions)


     2006

   2005

     2006

   2005

In-process research and development

     $ 74    $ 33      $ 86    $ 33

Transitional employee related costs

       2      11        12      11

Stock-based compensation

       4      1        9      1

Professional fees

       4      6        15      58
      

  

    

  

Total acquisition related charges

     $         84    $         51      $         122    $         103
      

  

    

  

 

6. BORROWINGS

 

Borrowings consisted of the following:

 

(Dollars in millions)


   February 28,
2006


        May 31,     
2005


Floating rate senior notes due January 2009

   $ 1,500    $

5.00% senior notes due January 2011, net of discount of $8

     2,242     

5.25% senior notes due January 2016, net of discount of $11

     1,989     

6.91% senior notes due February 2007

     150      153

Commercial paper notes

          1,993

OTC Loan Facility due May 2006

     188      700

Notes payable due May 2007

     6      6

Capital leases

     7     
    

  

Total borrowings

   $ 6,082    $ 2,852
    

  

Borrowings, current portion

   $ 341    $ 2,693
    

  

Borrowings, long-term portion

   $ 5,741    $ 159
    

  

 

$5.75 Billion Senior Notes

 

In January 2006, we issued $1.5 billion of floating rate senior notes (2009 Notes), $2.25 billion of 5.00% senior notes (2011 Notes) and $2.0 billion of 5.25% senior notes (2016 Notes) (collectively, the $5.75 billion senior notes) to finance the Siebel acquisition and for general corporate purposes. The 2009 Notes bear interest at a floating rate equal to three-month LIBOR plus 0.23% per year, the 2011 Notes bear interest at the rate of 5.00% per year, and the 2016 Notes bear interest at the rate of 5.25% per year. Interest is payable quarterly for the 2009 Notes and semi-annually for the 2011 Notes and 2016 Notes. The effective interest yield of the 2009 Notes, 2011 Notes and 2016 Notes at February 28, 2006 was 4.81%, 5.09% and 5.33%, respectively. We may redeem the 2009 Notes after January 2007 and may redeem the 2011 Notes and 2016 Notes at any time, subject to a make-whole premium.

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2006

(Unaudited)

 

The $5.75 billion senior notes were sold in a private placement to qualified institutional buyers in reliance on Rule 144A under the Securities Act of 1933, as amended (Securities Act), and in offshore transactions pursuant to Regulation S under the Securities Act. We entered into a registration rights agreement for the benefit of the holders of the $5.75 billion senior notes as we intend to register a series of notes with the Securities and Exchange Commission having substantially identical terms as each series of the $5.75 billion senior notes as part of a planned exchange offer. If we fail to perform our registration obligations set forth in the registration rights agreement, current holders of the $5.75 billion senior notes will be entitled to additional interest of 0.25% per year until such obligations are fulfilled.

 

$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 6.86% as of February 28, 2006. The fair value of the interest rate swap was $(0.4) million at February 28, 2006 and $3.1 million at May 31, 2005.

 

Short-Term Borrowings

 

In February 2006, we entered into dealer agreements with various financial institutions and an Issuing and Paying Agency Agreement with JPMorgan Chase Bank, National Association, relating to a new $3.0 billion commercial paper program (the New CP Program). Under the New CP Program, we may issue and sell unsecured short-term promissory notes pursuant to a private placement exemption from the registration requirements under federal and state securities laws. The New CP Program replaces the $3.0 billion commercial paper program of Old Oracle which was established in April 2005 and was terminated in February 2006 (the Old CP Program). We did not have any outstanding borrowings under the New CP Program at February 28, 2006.

 

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 4.79% at February 28, 2006. All amounts under the OTC Loan Facility are due in May 2006.

 

5-Year Revolving Credit Agreement

 

On March 15, 2006, we entered into a new $3.0 billion, 5-Year Revolving Credit Agreement (New Credit Agreement) with Wachovia Bank, National Association, Bank of America, N.A. and certain other lenders. The New Credit Agreement replaces the $3.0 billion 364-day Revolving Credit Agreement dated as of March 18, 2005 (Old Credit Agreement), which otherwise would have expired on March 17, 2006. The New Credit Agreement provides for an unsecured revolving credit facility which can be used to backstop any commercial paper that we may issue and for working capital and other general corporate purposes. Subject to certain conditions stated in the New Credit Agreement, we may borrow, prepay and re-borrow amounts under the facility at any time during the term of the New Credit Agreement. All amounts under the New Credit Agreement are due on March 14, 2011. Interest is based on either (a) a LIBOR-based formula or (b) a formula based on Wachovia’s prime rate or on the federal funds effective rate.

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2006

(Unaudited)

 

The New Credit Agreement also provides that (i) standby letters of credit may be issued on behalf of Oracle up to $500 million; and (ii) any amounts borrowed and letters of credit issued may be in Japanese Yen, Pounds Sterling and Euros up to $1.5 billion. We may also, upon the agreement of either then existing lenders or of additional banks not currently party to the New Credit Agreement, increase the commitments under this facility up to $5.0 billion. The New Credit Agreement contains certain customary representations and warranties, covenants and events of default, including the requirement that the total net debt to total capitalization ratio of Oracle not exceed 45%. We have not borrowed any funds under the New Credit Agreement.

 

We were in compliance with all debt-related covenants at February 28, 2006, including the requirement under the Old Credit Agreement that our total net debt to total capitalization ratio not exceed 40% as well as the registration requirements under our registration rights agreement. Future principal payments of our borrowings at February 28, 2006 are as follows: $189 million in fiscal 2006, $159 million in fiscal 2007, $3 million in fiscal 2008, $1.5 billion in fiscal 2009, and $2.25 billion in fiscal 2011 and $2.0 billion in fiscal 2016.

 

7. DEFERRED REVENUES

 

Deferred revenues consisted of the following:

 

(in millions)


   February 28,
2006


        May 31,     
2005


Software license updates and product support

   $ 2,118    $ 1,985

Services

     256      225

New software licenses

     93      79
    

  

Deferred revenues, current

     2,467      2,289

Deferred revenues, non-current

     111      126
    

  

Total deferred revenues

   $ 2,578    $ 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 nine months 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 $640 million to $426 million, which represents our estimate of the fair value of the support obligations assumed. As a result, software license

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2006

(Unaudited)

 

updates and product support revenues related to support contracts assumed in business acquisitions in the amount of $305 million, which would have been otherwise recorded by the acquired entities, were not recognized as revenue during the nine months ended February 28, 2006.

 

8. STOCK REPURCHASE PROGRAMS

 

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 February 28, 2006, 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 nine months ended February 28, 2006 and 2005, respectively. We did not repurchase any shares in the third quarter of fiscal 2006 or fiscal 2005. At February 28, 2006, approximately $1.6 billion was available to repurchase shares of our common stock pursuant to the stock repurchase program.

 

In connection with the Siebel acquisition in the third quarter of fiscal 2006, we issued approximately 141 million shares of our stock. Our Board of Directors has approved a separate program to repurchase shares to offset the amount of shares issued.

 

9. INCOME TAXES

 

The effective tax rate in all periods is the result of the mix of income earned in various tax jurisdictions that apply a broad range of income tax rates. The provision for income taxes differs from the tax computed at the federal statutory income tax rate due primarily to state taxes and earnings considered as indefinitely reinvested in foreign operations. The effective tax rate was 29.0% for the three and nine months ended February 28, 2006, and 30.0% for the three and nine months ended February 28, 2005.

 

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 recently finalized one bilateral Advance Pricing Agreement and currently are negotiating an additional bilateral agreement to cover the period from June 1, 2001 through May 31, 2008.

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2006

(Unaudited)

 

10. 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
February 28,


 

Nine Months Ended

February 28,


(in millions, except per share data)


      2006    

      2005    

      2006    

      2005    

Net income

  $ 765   $ 540   $ 2,081   $ 1,864
   

 

 

 

Weighted-average common shares outstanding

    5,207     5,122     5,169     5,133

Dilutive effect of employee stock plans

    97     108     93     96
   

 

 

 

Diluted weighted-average common shares outstanding

    5,304     5,230     5,262     5,229
   

 

 

 

Basic earnings per share

  $ 0.15   $ 0.11   $ 0.40   $ 0.36

Diluted earnings per share

  $ 0.14   $ 0.10   $ 0.40   $ 0.36

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

    149     117     122     135

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

 

11. COMPREHENSIVE INCOME

 

Comprehensive income includes foreign currency translation gains and losses, unrealized gains and losses on equity securities as well as 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
February 28,


   

Nine Months Ended

February 28,


 

(in millions)


      2006    

        2005    

        2006    

        2005    

 

Net income

  $ 765     $ 540     $ 2,081     $ 1,864  

Net foreign currency translation gain (loss)

    27       (6 )     (67 )     189  

Unrealized gain on equity securities, net

    6       3       15       2  

Equity hedge gain (loss), net

    (8 )     10       28       (24 )
   


 


 


 


Comprehensive income

  $ 790     $ 547     $ 2,057     $ 2,031  
   


 


 


 


 

17


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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2006

(Unaudited)

 

12. GOODWILL AND INTANGIBLE ASSETS

 

The changes in the carrying amount of goodwill, which is not deductible for tax purposes, for the nine months ended February 28, 2006, 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 (1)   $ 7,003

Allocation of goodwill (1)

     218      164      93      (475 )    

Goodwill acquired

     227      132      35      2,601 (2)     2,995

Goodwill adjustments

     13      59      5            77
    

  

  

  


 

Balance as of February 28, 2006

   $ 1,678    $ 5,218    $ 578    $ 2,601     $ 10,075
    

  

  

  


 


(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.
(2) Represents preliminary goodwill associated with our third quarter fiscal 2006 acquisitions, including Siebel, that will be allocated to operating segments upon finalization of our intangible asset valuation.

 

The changes in intangible assets for the nine months ended February 28, 2006 were as follows:

 

     Intangible Assets, Gross

   Accumulated Amortization

    Net Book Value

   Weighted
Average
Useful
Life


(Dollars in millions)


   May 31,
2005


   Additions

   Feb 28,
2006


   May 31,
2005


    Expense

    Feb 28,
2006


    May 31,
2005


   Feb 28,
2006


  

Software support agreements and related relationships

   $ 2,124    $ 837    $ 2,961    $ (88 )   $ (168 )   $ (256 )   $ 2,036    $ 2,705    10 years

Developed technology

     800      520      1,320      (127 )     (139 )     (266 )     673      1,054    5 years

Core technology

     368      222      590      (30 )     (61 )     (91 )     338      499    5 years

Customer relationships

     257      118      375      (11 )     (21 )     (32 )     246      343    10 years

Trademarks

     84      31      115      (4 )     (9 )     (13 )     80      102    7 years
    

  

  

  


 


 


 

  

    

Total

   $ 3,633    $ 1,728    $ 5,361    $ (260 )   $ (398 )   $ (658 )   $ 3,373    $ 4,703     
    

  

  

  


 


 


 

  

    

 

The total amortization expense related to intangible assets was $148 million and $398 million for the three and nine months ended February 28, 2006, respectively, and $81 million and $97 million for the three and nine months ended February 28, 2005, respectively. Estimated future amortization expense related to intangible assets is as follows:

 

(in millions)


   Year Ended
May 31,


2006 (remainder of fiscal year)

   $ 183

2007

     734

2008

     724

2009

     719

2010

     613

Thereafter

     1,730
    

Total

   $ 4,703
    

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2006

(Unaudited)

 

13. 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, analytics, 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.

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2006

(Unaudited)

 

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

 

     Three Months Ended
February 28,


   Nine Months Ended
February 28,


(in millions)


       2006    

       2005    

       2006    

       2005    

New software licenses:

                           

Revenues (1)

   $ 1,095    $ 946    $ 2,777    $ 2,476

Sales and distribution expenses

     622      537      1,699      1,366
    

  

  

  

Margin (2)

   $ 473    $ 409    $ 1,078    $ 1,110

Software license updates and product support:

                           

Revenues (1)

   $ 1,767    $ 1,531    $ 5,069    $ 3,959

Cost of services

     164      131      481      386
    

  

  

  

Margin (2)

   $ 1,603    $ 1,400    $ 4,588    $ 3,573

Total software business:

                           

Revenues (1)

   $ 2,862    $ 2,477    $ 7,846    $ 6,435

Expenses

     786      668      2,180      1,752
    

  

  

  

Margin (2)

   $ 2,076    $ 1,809    $ 5,666    $ 4,683

Consulting:

                           

Revenues (1)

   $ 500    $ 468    $ 1,485    $ 1,209

Cost of services

     434      404      1,271      1,025
    

  

  

  

Margin (2)

   $ 66    $ 64    $ 214    $ 184

On Demand:

                           

Revenues (1)

   $ 96    $ 77    $ 267    $ 226

Cost of services

     96      66      246      185
    

  

  

  

Margin (2)

   $    $ 11    $ 21    $ 41

Education:

                           

Revenues (1)

   $ 76    $ 71    $ 236    $ 194

Cost of services

     56      57      165      157
    

  

  

  

Margin (2)

   $ 20    $ 14    $ 71    $ 37

Total services business:

                           

Revenues (1)

   $ 672    $ 616    $ 1,988    $ 1,629

Cost of services

     586      527      1,682      1,367
    

  

  

  

Margin (2)

   $ 86    $ 89    $ 306    $ 262

Totals:

                           

Revenues (1)

   $ 3,534    $ 3,093    $ 9,834    $ 8,064

Expenses

     1,372      1,195      3,862      3,119
    

  

  

  

Margin (2)

   $ 2,162    $ 1,898    $ 5,972    $ 4,945
    

  

  

  


(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 $64 and $305 that was not recognized on the accompanying condensed consolidated statements of operations for the three and nine months ended February 28, 2006, respectively and $143 for the three and nine months ended February 28, 2005. See Note 7 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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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2006

(Unaudited)

 

Reconciliation of operating segment revenues to total revenues

 

     Three Months Ended
February 28,


   

Nine Months Ended

February 28,


 

(in millions)


       2006    

        2005    

        2006    

        2005    

 

Total revenues for reportable segments

   $ 3,534     $ 3,093     $ 9,834     $ 8,064  

Software license updates and product support revenues

     (64 )     (143 )     (305 )     (143 )
    


 


 


 


Total revenues

   $ 3,470     $ 2,950     $ 9,529     $ 7,921  
    


 


 


 


 

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

 

     Three Months Ended
February 28,


   

Nine Months Ended

February 28,


 

(in millions)


       2006    

        2005    

        2006    

        2005    

 

Total margin for reportable segments

   $ 2,162     $ 1,898     $ 5,972     $ 4,945  

Software license updates and product support revenues

     (64 )     (143 )     (305 )     (143 )

Product development and information technology expenses

     (538 )     (510 )     (1,550 )     (1,270 )

Marketing and partner program expenses

     (110 )     (111 )     (315 )     (286 )

Corporate and general and administrative expenses

     (120 )     (114 )     (326 )     (312 )

Amortization of intangible assets

     (148 )     (81 )     (398 )     (97 )

Acquisition related

     (84 )     (51 )     (122 )     (103 )

Restructuring

     (27 )     (107 )     (38 )     (107 )

Stock-based compensation

     (8 )     (10 )     (24 )     (10 )

Interest expense

     (49 )     (58 )     (86 )     (69 )

Non-operating income, net

     64       58       123       115  
    


 


 


 


Income before provision for income taxes

   $ 1,078     $ 771     $ 2,931     $ 2,663  
    


 


 


 


 

14. 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)

February 28, 2006

(Unaudited)

 

The maximum potential penalty under the CAP, by version, as of February 28, 2006 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 February 28, 2006, all but two contracts containing Version One of the CAP have expired by their terms. $76 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 February 28, 2006 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.

 

15. 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, although that date may change. Plaintiffs seek unspecified damages plus

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2006

(Unaudited)

 

interest, attorneys’ fees and costs, 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 the Court of Chancery’s grant of summary judgment. Regarding the Federal Derivative Action, on March 10, 2006, the parties submitted a stipulation to the Court, requesting that the action be dismissed. On March 20, 2006, the Court entered an Order, dismissing the action with prejudice, with each party to bear its own fees and costs.

 

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. On January 17, 2006, a purported Oracle stockholder filed a notice of appeal, challenging the judgment. On February 14, 2006, this purported stockholder requested that the appeal be dismissed, and the appeal was dismissed on February 16, 2006. The November 22, 2005 judgment is no longer subject to appeal.

 

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Table of Contents

ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2006

(Unaudited)

 

Siebel Securities Class Action

 

On March 10, 2004, William Wollrab, on behalf of himself and purportedly on behalf of a class of stockholders of Siebel Systems, Inc. (Siebel), filed a complaint in the United States District Court for the Northern District of California against Siebel and certain of its officers relating to predicted adoption rates of Siebel v7.0 and certain customer satisfaction surveys. This complaint was consolidated and amended on August 27, 2004, with the Policemen’s Annuity and Benefit Fund of Chicago being appointed to serve as lead plaintiff. The consolidated complaint also raised claims regarding Siebel’s business performance in 2002. In October 2004, Siebel filed a motion to dismiss, which was granted on January 28, 2005 with leave to amend. Plaintiffs filed an amended complaint on March 1, 2005. Plaintiffs seek unspecified damages plus interest, attorneys’ fees and costs, and equitable and injunctive relief. Siebel filed a motion to dismiss the amended complaint on April 27, 2005, and on December 28, 2005, the Court dismissed the case with prejudice. On January 17, 2006, plaintiffs filed a notice of appeal. We believe that we have meritorious defenses against this action, and we will continue vigorously to defend it.

 

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. On March 14, 2006 the court ruled that Oracle’s Real Application Clusters database option did not infringe the ‘377 patent. Oracle’s counterclaims against Mangosoft, alleging that the ‘377 patent is invalid and unenforceable, are the only claims that the Court has left open for trial. The court has not yet set a trial date for those two issues.

 

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.

 

24


Table of Contents
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. For further information regarding risks and uncertainties associated with Oracle’s business, please refer to the “Factors That May Affect Our Future Results or the Market Price of Our Stock” in the Management’s Discussion and Analysis on Financial Condition and Results of Operations section of the SEC filings of Oracle and its predecessor, Oracle Systems Corporation, including, but not limited to, our fiscal year 2005 annual report on Form 10-K, as amended, and quarterly reports on Form 10-Q for 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. 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.

 

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

 

25


Table of Contents

features and functionality of our software products are as strong as they have ever been. We have focused on 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 47% 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 75% 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.

 

We record 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 $64 million, $305 million, $143 million and $143 million that would have been otherwise recorded by acquired businesses as independent entities, were not recognized during the three and nine months ended February 28, 2006 and the three and nine months ended February 28, 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 20% 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 and the addition of personnel acquired from Siebel.

 

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 improving our 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 where 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

 

An active acquisition program is an important element of our corporate strategy. In the last two years, we have paid an aggregate of approximately $19 billion for our acquisitions, which include the following:

 

    In January 2006, we acquired Siebel Systems, Inc., a provider of customer relationship management software for approximately $6.1 billion. We expect to complete a majority of our planned legal-entity mergers, information system conversions and integration of Siebel’s operations by the end of fiscal 2006;

 

    In November 2005, 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 $600 million; and

 

    In January 2005, we acquired PeopleSoft Inc., a provider of enterprise application software products for approximately $11.1 billion. We completed our planned legal-entity mergers, information system conversions and integration of PeopleSoft’s operations in the first half of fiscal 2006.

 

We believe our recent acquisitions support our long-term strategic direction, strengthen our competitive position, particularly in the 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 expect to continue to acquire companies, products, services and technologies. See Note 3 of Notes to Condensed Consolidated Financial Statements for additional information related to our recent acquisitions.

 

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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.

 

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 valuations require 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.

 

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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 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 in the amount of $64 million, $305 million, $143 million and $143 million that would have been otherwise recorded by acquired businesses as independent entities, were not recognized during the three and nine months ended February 28, 2006 and the three and nine months ended February 28, 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 14 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

 

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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 the CAP as of February 28, 2006 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 13 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

 

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a customer for the license of software; (2) we deliver the products; (3) customer payment is deemed fixed or determinable and free of contingencies or significant uncertainties; and (4) collection is probable. Substantially all of our new software license revenues are recognized in this manner.

 

The vast majority of our software license arrangements include software license updates and product support, which are recognized ratably over the term of the arrangement, typically one year. Software license updates provide customers with rights to unspecified software product upgrades, maintenance releases and patches released during the term of the support period. Product support includes internet access to technical content, as well as internet and telephone access to technical support personnel. Software license updates and product support are generally priced as a percentage of the net new software license fees. 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 their 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.

 

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For arrangements with multiple elements, we allocate revenue to each element of a transaction based upon its fair value as determined by “vendor specific objective evidence.” Vendor specific objective evidence of fair value for all elements of an arrangement is based upon the normal pricing and discounting practices for those products and services when sold separately and for software license updates and product support services, is additionally measured by the renewal rate offered to the customer. We may modify our pricing practices in the future, which could result in changes in our vendor specific objective evidence of fair value for these undelivered elements. As a result, our future revenue recognition for multi-element arrangements could differ significantly from our historical results.

 

We defer revenue for any undelivered elements, and recognize revenue when the product is delivered or over the period in which the service is performed, in accordance with our revenue recognition policy for such element. If we cannot objectively determine the fair value of any undelivered element included in bundled software and service arrangements, we defer revenue until all elements are delivered and services have been performed, or until fair value can objectively be determined for any remaining undelivered elements. When the fair value of a delivered element has not been established, we use the residual method to record revenue if the fair value of all undelivered elements is determinable. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is allocated to the delivered elements and is recognized as revenue.

 

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.

 

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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 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 second quarter of fiscal 2006, we recognized new software license revenues of approximately $33 million from a supplier. During the third quarter of fiscal 2006, we negotiated to acquire goods and services from this supplier and finalized terms of the purchase. The value of the goods and services we will acquire from this supplier under this agreement will 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

 

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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.

 

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 are generally not 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 generally not tax deductible; however, deferred taxes have been recorded for non-deductible amortization expense 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.

 

We are required to adopt the provisions of Statement 123(R) in fiscal 2007, with early-adoption permitted. 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 operating expenses, 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. We currently estimate that the adoption of Statement 123(R) will increase operating expenses by $250 to $300 million on an annual basis.

 

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

 

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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.

 

Results of Operations

 

The fluctuations in operating results of Oracle in the third quarter and first nine months of fiscal 2006 compared with the same periods in fiscal 2005 are generally due to acquisitions, principally PeopleSoft in the third quarter of fiscal 2005, and, to a lesser extent, Siebel in the third quarter of fiscal 2006.

 

In our discussion of changes in our results of operations from the third quarter and first nine months of fiscal 2006 compared to the third quarter and first nine months of fiscal 2005, we quantify the contribution of PeopleSoft, Siebel and Retek products to growth in new software licenses applications revenue, the amount of software license updates and product support revenues associated with PeopleSoft and Siebel products and services and present supplemental disclosure related to acquisition accounting where applicable. Additionally, we provide information regarding incremental consulting, On Demand and education revenues associated with Siebel and incremental expenses associated with Siebel in the third quarter of fiscal 2006. 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 also plan to integrate Siebel sales and services personnel into our existing operations, and therefore, we may not be able to quantify incremental Siebel revenues and expenses in future quarters. 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, and our plans to integrate the Siebel sales force. The commissions earned by our integrated sales force in the PeopleSoft integration 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 acquisitions of PeopleSoft and Siebel 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 February 28, 2006 and February 28, 2005, our financial statements would reflect revenues of $1.19

 

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million for the nine months ended February 28, 2006 (using 1.19 as the exchange rate) and $0.8 million for the nine months ended February 28, 2005 (using 0.80 as the exchange rate). The constant currency presentation would translate the results for the nine months ended February 28, 2006 and 2005 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.

 

Total Revenues and Operating Expenses

 

     Three Months Ended February 28,

   Nine Months Ended February 28,

          Percent Change

             Percent Change

    

(Dollars in millions)


       2006    

   Actual

   Constant

       2005    

       2006    

   Actual

   Constant

       2005    

Total Revenues by Geography:

                                               

Americas

   $ 1,848    29%    27%    $ 1,437    $ 5,057    32%    31%    $ 3,820

EMEA (1) 

     1,164    7%    17%      1,088      3,136    7%    13%      2,928

Asia Pacific

     458    8%    14%      425      1,336    14%    17%      1,173
    

            

  

            

Total revenues

     3,470    18%    22%      2,950      9,529    20%    22%      7,921

Total Operating Expenses

     2,418    11%    14%      2,180      6,650    25%    27%      5,306
    

            

  

            

Total Operating Margin

   $ 1,052    37%    45%    $ 770    $ 2,879    10%    13%    $ 2,615
    

            

  

            

Total Operating Margin %

     30%                26%      30%                33%

% Revenues by Geography:

                                               

Americas

     53%                49%      53%                48%

EMEA

     34%                37%      33%                37%

Asia Pacific

     13%                14%      14%                15%

Total Revenues by Business:

                                               

Software

   $ 2,799    20%    24%    $ 2,336    $ 7,547    20%    22%    $ 6,297

Services

     671    9%    13%      614      1,982    22%    24%      1,624
    

            

  

            

Total revenues

   $ 3,470    18%    22%    $ 2,950    $ 9,529    20%    22%    $ 7,921
    

            

  

            

% Revenues by Business:

                                               

Software

     81%                79%      79%                79%

Services

     19%                21%      21%                21%

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

 

Fiscal Third Quarter 2006 Compared to Fiscal Third Quarter 2005:  Total revenues were negatively affected by foreign currency rate fluctuations of 4 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 58% to the growth in total revenues, whereas new software license and consulting revenues contributed 30% and 8%, respectively. On a constant currency basis, the Americas contributed 63% to the increase in total revenues, EMEA contributed 28% and Asia Pacific contributed 9%.

 

Operating expenses were favorably affected by 3 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 as well as greater amortization of intangible assets, offset partially by lower restructuring and acquisition related expenses. Operating margins as a percentage of total revenues increased from 26% to 30% due to the growth in software revenues as well as lower restructuring and acquisition related expenses associated with the Siebel acquisition in fiscal 2006 as compared to the PeopleSoft acquisition in fiscal 2005.

 

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International operations will continue to provide a significant portion of total revenues. As a result, total revenues and expenses will be affected by changes in the relative strength of the United States dollar against certain major international currencies.

 

First Nine Months Fiscal 2006 Compared to First Nine Months Fiscal 2005:  Total revenues were negatively affected by foreign currency rate fluctuations of 2 percentage points. Excluding the effect of currency rate fluctuations, software license updates and product support revenues contributed 57% to the growth in total revenues, whereas new software license and consulting revenues contributed 21% and 17%, respectively. On a constant currency basis, the Americas contributed 67% to the increase in total revenues, EMEA contributed 22% and Asia Pacific contributed 11%.

 

Operating expenses were favorably affected by 2 percentage points. Excluding the effect of currency rate fluctuations, the increase in operating expenses is primarily due to the same reasons noted above. The total operating margin as a percentage of revenues declined from 33% to 30% in the first nine months of 2006 as expenses, including amortization of intangible assets, grew at a faster rate than revenues.

 

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    
February 28,


   

    Nine Months Ended    

February 28,


 

(in millions)


   2006

    2005

    2006

    2005

 

Support deferred revenue (1)

   $ 64     $ 143     $ 305     $ 143  

Amortization of intangible assets (2)

     148       81       398       97  

Acquisition related charges (3) (5)

     84       51       122       103  

Restructuring (4)

     27       107       38       107  

Stock-based compensation (5)

     8       10       24       10  

Income tax effect (6)

     (96 )     (118 )     (257 )     (138 )
    


 


 


 


     $ 235     $ 274     $ 630     $ 322  
    


 


 


 



(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 nine months of fiscal 2006. Due to our application of business combination accounting rules, software license updates and product support revenues related to support contracts in the amount of $64, $305, $143 and $143 that would have been otherwise recorded by acquired businesses as independent entities, were not recognized during the three and nine months ended February 28, 2006 and the three and nine months ended February 28, 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:

 


   Year Ended
May 31,


2006 (remainder of fiscal year)

   $ 87

2007

     137

2008

     9
    

Total

   $ 233
    

 

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

 

(2) Represents the amortization of intangible assets acquired in connection with acquisitions, primarily PeopleSoft and Siebel. Estimated future amortization expense related to intangible assets is as follows:

 


   Year Ended
May 31,


2006 (remainder of fiscal year)

   $ 183

2007

     734

2008

     724

2009

     719

2010

     613

Thereafter

     1,730
    

Total

   $ 4,703
    

 

(3) Acquisition related charges primarily consist of in-process research and development expenses, integration-related professional services, stock-based 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 restructuring plans initiated in the third quarter of fiscal 2006 and 2005.

 

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

 

     Three Months Ended
February 28,


  

Nine Months Ended

February 28,



   2006

   2005

   2006

   2005

Sales and marketing

   $ 2    $ 2    $ 5    $ 2

Software license updates and product support

     1      1      2      1

Cost of services

     2      3      6      3

Research and development

     3      3      11      3

General and administrative

          1           1
    

  

  

  

Subtotal

     8      10      24      10

Acquisition related charges

     4      1      9      1
    

  

  

  

Total

   $ 12    $ 11    $ 33    $ 11
    

  

  

  

 

As of February 28, 2006, the portion of the intrinsic value of unvested options assumed from acquired companies related to future service, which is approximately $42, 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.

 

Stock-based compensation included in acquisition related charges resulted from unvested options assumed from acquisitions 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 29.0% in the third quarter and first nine months of fiscal 2006 and 30.0% in the third quarter and first nine months of fiscal 2005.

 

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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 February 28,

   Nine Months Ended February 28,

          Percent Change

             Percent Change

    

(Dollars in millions)


       2006    

   Actual

   Constant

       2005    

       2006    

   Actual

   Constant

       2005    

New Software License Revenues:

                                               

Americas

   $ 487    25%    23%    $ 390    $ 1,259    23%    21%    $ 1,027

EMEA

     413    11%    22%      370      975    3%    10%      943

Asia Pacific

     196    5%    11%      187      549    8%    11%      511
    

            

  

            

Total revenues

     1,096    16%    20%      947      2,783    12%    15%      2,481

Expenses:

                                               

Sales and marketing (1) 

     754    13%    16%      666      2,071    22%    23%      1,701

Stock-based compensation

     2    *    *      2      5    *    *      2

Amortization of intangible
assets
(2) 

     54    *    *      33      139    *    *      33
    

            

  

            

Total expenses

     810    15%    19%      701      2,215    28%    29%      1,736
    

            

  

            

Total Margin

   $ 286    17%    24%    $ 246    $ 568    -24%    -20%    $ 745
    

            

  

            

Total Margin %

     26%                26%      20%                30%

% Revenues by Geography:

                                               

Americas

     44%                41%      45%                41%

EMEA

     38%                39%      35%                38%

Asia Pacific

     18%                20%      20%                21%

Revenues by Product:

                                               

Database technology

   $ 819    5%    9%    $ 782    $ 2,097    4%    6%    $ 2,017

Applications

     269    77%    82%      152      662    52%    54%      436
    

            

  

            

Total revenues by product

     1,088    16%    20%      934      2,759    12%    15%      2,453

Other revenues

     8    -45%    -44%      13      24    -16%    -15%      28
    

            

  

            

Total new software license revenues

   $ 1,096    16%    20%    $ 947    $ 2,783    12%    15%    $ 2,481
    

            

  

            

% Revenues by Product:

                                               

Database technology

     75%                84%      76%                82%

Applications

     25%                16%      24%                18%

(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 Third Quarter 2006 Compared to Fiscal Third Quarter 2005:  New software license revenues were negatively affected by foreign currency rate fluctuations of 4 percentage points. Excluding the effect of currency rate fluctuations, the Americas contributed 49% to the increase in new software license revenues, EMEA contributed 40% and Asia Pacific contributed 11%.

 

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 9% in the third quarter and on a trailing 4-quarter basis. Database revenues increased 7% in the third quarter and on a trailing 4-quarter basis. The growth in database revenues was primarily driven by increased demand for database option products, which grew 14% and 15% in the third quarter and on a trailing 4-quarter basis, respectively. Middleware revenues grew 28% in the third quarter and 23% 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. Middleware revenues also include $7 million of revenues from the licensing of Siebel products in the third quarter of fiscal 2006.

 

PeopleSoft products contributed $42 million to the growth in applications revenue in the third quarter of fiscal 2006, Oracle products contributed $34 million, Siebel products contributed $21 million and Retek products contributed $20 million. Excluding the effect of currency rate fluctuations, applications revenue increased 82% and 52% in the third quarter of fiscal 2006 and on a trailing 4-quarter basis, respectively. The growth in our applications sales is the result of increased demand for our applications products, including products from acquired companies, 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 and EMEA.

 

New software license revenues earned from transactions over $0.5 million increased from 35% of new software license revenues in the third quarter of fiscal 2005 to 39% in the third quarter of fiscal 2006.

 

Sales and marketing expenses in the third quarter of fiscal 2006 include incremental Siebel expenses of $33 million. Excluding the effect of currency rate fluctuations, sales and marketing expenses increased due to higher headcount levels resulting in increased personnel related costs, higher benefit expenses per head, higher commission expenses resulting from a 20% growth in license revenues and higher marketing expenses, primarily due to incremental Siebel marketing expenditures. The total new software license margin as a percentage of revenues remained flat.

 

First Nine Months Fiscal 2006 Compared to First Nine Months Fiscal 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 contributed 60%, EMEA contributed 25% and Asia Pacific contributed 15%.

 

PeopleSoft products contributed $163 million to the growth in applications revenue in the first nine months of fiscal 2006, Retek products contributed $26 million, Siebel products contributed $21 million and Oracle products contributed $16 million. Excluding the effect of currency rate fluctuations, the growth in new software license revenues in the first nine months of fiscal 2006 is due to a 5% increase in database revenues, 21% increase in middleware revenues and a 54% increase in application revenues.

 

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New software license revenues earned from transactions over $0.5 million increased from 35% of new software license revenues in the first nine months of fiscal 2005 to 37% in the first nine months of fiscal 2006.

 

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

 

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 February 28,

   Nine Months Ended February 28,

(Dollars in millions)


       2006    

   Percent Change

       2005    

       2006    

   Percent Change

       2005    

      Actual

   Constant

         Actual

   Constant

  

Software License Updates and Product Support Revenues:

                              

Americas

   $ 989    37%    35%    $ 724    $ 2,718    38%    37%    $ 1,963

EMEA

     516    6%    17%      484      1,467    9%    15%      1,348

Asia Pacific

     198    9%    16%      181      579    15%    17%      505
    

            

  

            

Total revenues

     1,703    23%    27%      1,389      4,764    25%    27%      3,816

Expenses:

                                               

Software license updates and product support (1)

     177    11%    14%      160      512    17%    18%      437

Stock-based compensation

     1    *    *      1      2    *    *      1

Amortization of intangible assets (2)

     90    *    *      38      244    *    *      38
    

            

  

            

Total expenses

     268    35%    38%      199      758    59%    61%      476
    

            

  

            

Total Margin

   $ 1,435    20%    25%    $ 1,190    $ 4,006    20%    22%    $ 3,340
    

            

  

            

Total Margin %

     84%                86%      84%                88%

% Revenues by Geography:

                                               

Americas

     58%                52%      57%                52%

EMEA

     30%                35%      31%                35%

Asia Pacific

     12%                13%      12%                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

 

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Fiscal Third Quarter 2006 Compared to Fiscal Third Quarter 2005:  Excluding the effect of currency rate fluctuations, software license updates and product support revenues increased as a result of incremental revenues from the expansion of our customer base resulting from acquisitions, 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 70% to the growth in software license updates and product support revenues, EMEA contributed 22% and Asia Pacific contributed 8%.

 

Software license updates and product support revenues in the third quarter of fiscal 2006 include incremental revenues of $204 million from PeopleSoft contracts and $17 million from Siebel contracts over the prior year corresponding period. The increase in PeopleSoft revenues is due primarily to a full quarter of software license updates and product revenues in the third quarter of fiscal 2006 compared to only two months of revenues in the third quarter of fiscal 2005, as well as higher revenues recognized upon the renewal of contracts assumed from the PeopleSoft acquisition, as described below.

 

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 amounts of $64 million and $143 million that would have been otherwise recorded by our acquired businesses as independent entities, were not recognized in the third quarter of fiscal 2006 and 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.

 

Software license updates and product support expenses increased primarily due to increased headcount levels and salary increases, higher commissions and bonuses as a result of increased revenue levels, increased benefit expenses per head and incremental expenses from Siebel of $5 million

 

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

 

First Nine Months Fiscal 2006 Compared to First Nine Months 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 include incremental revenues of $645 million from PeopleSoft contracts and $17 million from Siebel contracts over the prior year corresponding period. Excluding the effect of currency rate fluctuations, the Americas contributed 72% to the growth in software license updates and product support revenues, EMEA contributed 19% and Asia Pacific contributed 9%. Software license updates and product support revenues related to support contracts in the amount of $305 million and $143 million that would have been otherwise recorded by PeopleSoft, Siebel and other acquired businesses as independent entities, were not recognized in the first nine months of fiscal 2006 and 2005, respectively.

 

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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 February 28,

   Nine Months Ended February 28,

(Dollars in millions)


       2006    

   Percent Change

       2005    

       2006    

   Percent Change

       2005    

      Actual

   Constant

         Actual

   Constant

  

Consulting Revenues:

                                               

Americas

   $ 279    11%    10%    $ 251    $ 819    28%    27%    $ 639

EMEA

     181    -1%    8%      183      533    8%    14%      491

Asia Pacific

     41    13%    19%      36      137    50%    53%      91
    

            

  

            

Total revenues

     501    7%    10%      470      1,489    22%    24%      1,221

Expenses:

                                               

Cost of services (1)

     453    6%    9%      427      1,324    23%    24%      1,081

Stock-based compensation

     2    *    *      3      6    *    *      3

Amortization of intangible assets (2)

     1    *    *      2      3    *    *      2
    

            

  

            

Total expenses

     456    6%    9%      432      1,333    23%    25%      1,086
    

            

  

            

Total Margin

   $ 45    16%    19%    $ 38    $ 156    14%    18%    $ 135
    

            

  

            

Total Margin %

     9%                8%      10%                11%

% Revenues by Geography:

                                               

Americas

     56%                53%      55%                52%

EMEA

     36%                39%      36%                40%

Asia Pacific

     8%                8%      9%                8%

 


(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 Third Quarter 2006 Compared to Fiscal Third Quarter 2005:  The increase in consulting revenues in the third quarter of fiscal 2006 from the prior year corresponding period 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, including incremental revenues from Siebel contracts of $18 million. Excluding the effect of currency rate fluctuations, the Americas contributed 55% to the growth in consulting revenues, EMEA contributed 31% and Asia Pacific contributed 14%.

 

Consulting expenses in the third quarter of fiscal 2006 include incremental Siebel expenses of $18 million. Excluding the effect of currency rate fluctuations, consulting expenses increased as a result of higher salary and variable compensation expenses due to an increase in headcount due to acquired Siebel employees, higher benefit expenses per head and higher external contractor costs due to high employee attrition.

 

First Nine Months Fiscal 2006 Compared to First Nine Months 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 60% to the growth in consulting revenues, EMEA contributed 24% and Asia Pacific contributed 16%.

 

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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 February 28,

   Nine Months Ended February 28,

(Dollars in millions)


       2006    

    Percent Change

       2005    

       2006    

   Percent Change

       2005    

     Actual

   Constant

         Actual

   Constant

  

On Demand Revenues:

                                                

Americas

   $ 58     37%    36%    $ 42    $ 155    29%    28%    $ 119

EMEA

     27     15%    26%      24      79    15%    21%      69

Asia Pacific

     11     6%    9%      10      32    7%    6%      31
    


           

  

            

Total revenues

     96     26%    29%      76      266    22%    23%      219

Cost of services

     99     51%    55%      66      254    44%    46%      176
    


           

  

            

Total Margin

   $ (3 )   -128%    -130%    $ 10    $ 12    -72%    -72%    $ 43
    


           

  

            

Total Margin %

     -3%                 13%      5%                20%

% Revenues by Geography:

                                                

Americas

     60%                 55%      58%                54%

EMEA

     29%                 32%      30%                32%

Asia Pacific

     11%                 13%      12%                14%

 

Fiscal Third Quarter 2006 Compared to Fiscal Third Quarter 2005:  On Demand revenues increased in the third quarter of fiscal 2006 from the prior year corresponding period due to the expansion of our subscription base in Oracle On Demand services, including incremental revenues from Siebel of $2 million, as well as higher revenues from Advanced Customer Services, including incremental revenues from Siebel of $7 million. Excluding the effect of currency rate fluctuations, the Americas contributed 69% to the increase in On Demand revenues, EMEA contributed 27% and Asia Pacific contributed 4%.

 

On Demand expenses increased primarily due to higher headcount levels and associated personnel related expenditures, higher external contractor costs, higher computer and technology related charges and incremental Siebel headcount and related expenditures of $4 million. Advanced Customer Services expenses increased $8 million due to incremental Siebel headcount and related expenditures.

 

First Nine Months Fiscal 2006 Compared to First Nine Months 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 67% to the growth in On Demand revenues, EMEA contributed 29% and Asia Pacific contributed 4%.

 

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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 February 28,

   Nine Months Ended February 28,

(Dollars in millions)


       2006    

   Percent Change

       2005    

       2006    

   Percent Change

       2005    

      Actual

   Constant

         Actual

   Constant

  

Education Revenues:

                                               

Americas

   $ 35    16%    15%    $ 30    $ 106    48%    46%    $ 72

EMEA

     27    1%    11%      27      82    7%    12%      77

Asia Pacific

     12    7%    12%      11      39    11%    12%      35
    

            

  

            

Total revenues

     74    9%    13%      68      227    24%    26%      184

Cost of services

     58    0%    2%      59      173    6%    7%      163
    

            

  

            

Total Margin

   $ 16    63%    86%    $ 9    $ 54    166%    174%    $ 21
    

            

  

            

Total Margin %

     21%                13%      24%                11%

% Revenues by Geography:

                                               

Americas

     47%                44%      47%                39%

EMEA

     37%                40%      36%                42%

Asia Pacific

     16%                16%      17%                19%

 

Fiscal Third Quarter 2006 Compared to Fiscal Third Quarter 2005:  Education revenues increased in the third quarter of fiscal 2006 from the prior year corresponding period due to an increase in customer training on the use of our applications products, including incremental revenues from Siebel of $3 million. Excluding the effect of currency rate fluctuations, the Americas contributed 52%, EMEA contributed 32% and Asia Pacific contributed 16% to the overall increase in education revenues.

 

Excluding the effect of currency rate fluctuations, the increase in education expenses is due to incremental headcount and associated personnel related expenditures of Siebel education employees.

 

First Nine Months Fiscal 2006 Compared to First Nine Months 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 71% to the growth in education revenues, EMEA contributed 20% and Asia Pacific contributed 9%.

 

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 February 28,

  Nine Months Ended February 28,

        2006    

  Percent Change

      2005    

      2006    

  Percent Change

      2005    

(Dollars in millions)


    Actual

  Constant

      Actual

  Constant

 

Research and development (1)

  $ 464   14%   13%   $ 408   $ 1,324   28%   28%   $ 1,031

Stock-based compensation

    3   *   *     3     11   *   *     3

Amortization of intangible assets (2) 

    4   *   *     8     12   *   *     24
   

         

 

         

Total expenses

  $ 471   12%   13%   $ 419   $ 1,347   27%   27%   $ 1,058

% of Total Revenues

    14%             14%     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

 

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Table of Contents

Fiscal Third Quarter 2006 Compared to Fiscal Third Quarter 2005:  Research and development headcount increased in the third quarter of fiscal 2006 from the prior year corresponding period by 10% in the database and middleware divisions, and 8% in the applications division primarily due to the addition of Siebel employees. Research and development expenses increased due to incremental Siebel expenses of $19 million, primarily related to salary and employee related costs, as well as higher external contractor costs.

 

First Nine Months Fiscal 2006 Compared to First Nine Months 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 February 28,

   Nine Months Ended February 28,

         2006    

   Percent Change

       2005    

       2006    

   Percent Change

       2005    

(Dollars in millions)


      Actual

   Constant

         Actual

   Constant

  

General and administrative

   $ 146    0%    2%    $ 145    $ 410    3%    3%    $ 400

Stock-based compensation

        *    *      1         *    *      1
    

            

  

            

Total expenses

   $ 146    0%    3%    $ 146    $ 410    2%    3%    $ 401

% of Total Revenues

     4%                5%      4%                5%

* not meaningful

 

Fiscal Third Quarter 2006 Compared to Fiscal Third Quarter 2005:  Excluding the effect of currency rate fluctuations, general and administrative expenses increased due to higher legal costs.

 

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

 

Amortization of Intangible Assets:

 

     Three Months Ended
February 28,


  

Nine Months Ended

February 28,


(in millions)


       2006    

       2005    

       2006    

       2005    

Software support agreements and related relationships

   $ 61    $ 35    $ 168    $ 35

Developed technology

     53      28      139      44

Core technology

     23      12      61      12

Customer contracts

     8      4      21      4

Trademarks

     3      2      9      2
    

  

  

  

Total amortization of intangible assets

   $ 148    $ 81    $ 398    $ 97
    

  

  

  

 

Fiscal Third Quarter 2006 Compared to Fiscal Third Quarter 2005:  Amortization of intangible assets increased due to amortization of purchased intangibles from Siebel and other acquisitions made in the past twelve months as well as a full quarter of amortization related to the PeopleSoft acquisition compared to only two months of amortization in the prior year corresponding period.

 

First Nine Months Fiscal 2006 Compared to First Nine Months Fiscal 2005:  Amortization of intangible assets increased primarily from purchased intangible assets associated with our acquisition of PeopleSoft.

 

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Table of Contents

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

 

     Three Months Ended
February 28,


  

Nine Months Ended

February 28,


(in millions)


       2006    

       2005    

       2006    

       2005    

In-process research and development

   $ 74    $ 33    $ 86    $ 33

Transitional employee related costs

     2      11      12      11

Stock-based compensation

     4      1      9      1

Professional fees

     4      6      15      58
    

  

  

  

Total acquisition related charges

   $ 84    $ 51    $ 122    $ 103
    

  

  

  

 

Fiscal Third Quarter 2006 Compared to Fiscal Third Quarter 2005:  Acquisition related charges increased due to higher in-process research and development charges, partially offset by lower transitional employee related expenses.

 

First Nine Months Fiscal 2006 Compared to First Nine Months Fiscal 2005:  Acquisition related charges increased in the first nine months of fiscal 2006 due to higher in-process research and development charges and stock-based compensation charges, partially offset by lower professional fees. Professional fees in the first nine months of fiscal 2005 included costs associated with our tender offer for PeopleSoft prior to the agreement date.

 

Restructuring:  Restructuring expenses primarily consist of Oracle employee severance costs and Oracle duplicate facilities closures related to plans initiated in the third quarter of fiscal 2006 as well as plans initiated in the third quarter of fiscal 2005.

 

     Three Months Ended
February 28,


  

Nine Months Ended

February 28,


(in millions)


       2006    

       2005    

       2006    

       2005    

Severance costs

   $ 26    $ 91    $ 37    $ 91

Excess facilities

          16           16

Other

     1           1     
    

  

  

  

Total restructuring charges

   $ 27    $ 107    $ 38    $ 107
    

  

  

  

 

Restructuring expenses decreased in the third quarter and first nine months of fiscal 2006 due to higher severance and facility charges incurred with the restructuring plans initiated in the third quarter of fiscal 2005. For additional information regarding the Oracle restructuring plans, as well as restructuring activities of our acquired companies, please see Note 3 of Notes to Condensed Consolidated Financial Statements.

 

Interest Expense:  Interest expense primarily relates to our borrowings under various bridge loans and short-term facilities to fund some of our recent acquisitions. Additionally, in January 2006, we issued $5.75 billion in notes to fund the Siebel acquisition and for general corporate purposes. These notes, which were issued in three tranches, mature in January 2009, January 2011 and January 2016, respectively.

 

     Three Months Ended February 28,

   Nine Months Ended February 28,

         2006    

   Percent Change

       2005    

       2006    

   Percent Change

       2005    

(Dollars in millions)


      Actual

   Constant

         Actual

   Constant

  

Interest expense

   $ 49    -15%    -15%    $ 58    $ 86    25%    26%    $ 69

 

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Table of Contents

Fiscal Third Quarter 2006 Compared to Fiscal Third Quarter 2005:  Interest expense decreased in the third quarter of fiscal 2006 due to higher average interest rates on our borrowings in the prior year corresponding period. Interest expense in the third quarter of fiscal 2005 primarily related to a $9.2 billion bridge loan entered into in December 2004 in connection with the PeopleSoft acquisition and repaid in full as of May 2005; whereas, interest expense in the third quarter of fiscal 2006 includes the effect of the $5.75 billion senior notes issued in January 2006 as well as additional borrowings on our commercial paper program. We expect that interest expense will increase in future quarters due to our January 2006 note issuances.

 

First Nine Months Fiscal 2006 Compared to First Nine Months Fiscal 2005:  Interest expense increased in the first nine months of fiscal 2006 compared to the prior year corresponding period due to higher average borrowings related to outstanding balances under our commercial paper program and unsecured loan facility as well as the $5.75 billion senior notes issued in January 2006. Interest expense in the first nine months of fiscal 2005 primarily reflects interest under our $9.2 billion bridge loan.

 

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, including equity in earnings of equity method investments, and the minority interest share in the net profits of Oracle Japan.

 

    Three Months Ended February 28,

    Nine Months Ended February 28,

 
        2006    

    Percent Change

      2005    

        2006    

    Percent Change

      2005    

 

(Dollars in millions)


    Actual

  Constant

      Actual

  Constant

 

Interest income

  $ 50     -13%   -12%   $ 57     $ 99     -28%   -27%   $ 137  

Foreign currency gains (losses)

    16     *   *     (7 )     29     *   *     (18 )

Net investment gains related to
equity securities

    8     *   *           12     *   *     1  

Minority interest

    (9 )   13%   13%     (8 )     (27 )   -3%   -3%     (27 )

Other

    10     -21%   -22%     17       25     15%   17%     24  
   


         


 


         


Total non-operating income, net

  $ 75     27%   28%   $ 59     $ 138     18%   19%   $ 117  
   


         


 


         



* not meaningful

 

The increase in non-operating income, net in the third quarter and first nine months of fiscal 2006 compared to the prior year comparable period 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 third quarter and first nine months of fiscal 2006, the weighted average interest rate earned on cash, cash equivalents and marketable securities increased from 2.04% to 3.41% and 1.85% to 2.72%, 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 increased in the third quarter and first nine months of fiscal 2006 due to higher earnings, partially offset by a lower effective tax rate. The decrease in the effective tax rate from 30.0% in the third quarter and first nine months of fiscal 2005 to 29.0% in the third quarter and first nine months of fiscal 2006 is attributable to a higher ratio of earnings from lower tax rate jurisdictions.

 

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Table of Contents

Liquidity and Capital Resources

 

(Dollars in millions)


   February 28,
2006


   Change

       May 31,    
2005


Working capital

   $ 5,333    1,285%    $ 385

Cash, cash equivalents and marketable securities

   $ 7,764    63%    $ 4,771