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 29, 2016

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: 001-35992

 

 

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)   (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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer    x    Accelerated filer    ¨
Non-accelerated filer    ¨    Smaller reporting company    ¨
(Do not check if a smaller reporting company)   

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 March 11, 2016 was: 4,149,865,000.

 

 

 


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 29, 2016 and May 31, 2015     3   
 

Condensed Consolidated Statements of Operations for the Three and Nine Months Ended February  29, 2016 and February 28, 2015

    4   
 

Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months  Ended February 29, 2016 and February 28, 2015

    5   
 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended February  29, 2016 and February 28, 2015

    6   
  Notes to Condensed Consolidated Financial Statements     7   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations     26   

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk     49   

Item 4.

  Controls and Procedures     49   

PART II.

  OTHER INFORMATION  

Item 1.

  Legal Proceedings     50   

Item 1A.

  Risk Factors     50   

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds     50   

Item 6.

  Exhibits     51   
  Signatures     52   


Table of Contents

Cautionary Note on Forward-Looking Statements

For purposes of this Quarterly Report, the terms “Oracle,” “we,” “us” and “our” refer to Oracle Corporation and its consolidated subsidiaries. This Quarterly Report on Form 10-Q contains statements that are not historical in nature, are predictive in nature, or that depend upon or refer to future events or conditions or otherwise contain forward-looking statements within the meaning of Section 21 of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. These include, among other things, statements regarding:

 

   

our expectation that we will continue to acquire companies, products, services and technologies to further our corporate strategy;

 

   

our belief that our acquisitions should allow us to grow and continue to make investments in research and development;

 

   

continued realization of gains or losses with respect to our foreign currency exposures;

 

   

our expectation that the total revenues of our cloud and on-premise software business generally will continue to increase;

 

   

our belief that software license updates and product support revenues and margins will grow;

 

   

our expectation that our hardware business will have lower operating margins as a percentage of revenues than our cloud and on-premise software business;

 

   

our intention that we will renew our cloud software as a service (SaaS) and cloud platform as a service (PaaS) contracts when they are eligible for renewal;

 

   

our expectation that we will continue to place significant strategic emphasis on growing our cloud SaaS and PaaS revenues, which will affect the growth of our cloud SaaS and PaaS revenues and our new software license revenues;

 

   

our international operations providing a significant portion of our total revenues and expenses;

 

   

our expectation that we will continue to make significant investments in research and development and related product opportunities, including those related to hardware products and services, and our belief that research and development efforts are essential to maintaining our competitive position;

 

   

the sufficiency of our sources of funding for working capital, capital expenditures, contractual obligations, acquisitions, dividends, stock repurchases, debt repayments and other matters;

 

   

our belief that we have adequately provided for any reasonably foreseeable outcomes related to our tax audits and our belief that our net deferred tax assets will be realized in the foreseeable future;

 

   

our belief that the outcome of certain legal proceedings and claims to which we are a party will not, individually or in the aggregate, result in losses that are materially in excess of amounts already recognized, if any;

 

   

our expectations regarding the timing and amount of expenses relating to the Fiscal 2015 Oracle Restructuring Plan and the improved efficiencies in our operations that such plan will create;

 

   

the timing and amount of our stock repurchases;

 

   

our expectation that to the extent customers renew support contracts or cloud SaaS and cloud PaaS contracts, we will recognize revenues for the full contracts’ values over the respective renewal periods;

 

   

our ability to predict quarterly hardware revenues;

as well as other statements regarding our future operations, financial condition and prospects, and business strategies. Forward-looking statements may be preceded by, followed by or include the words “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “strives,” “estimates,” “will,” “should,” “is designed to” and similar expressions. We claim the protection of the safe harbor for forward-looking statements contained in

 

1


Table of Contents

the Private Securities Litigation Reform Act of 1995 for all forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events. These forward-looking statements are subject to risks, uncertainties and assumptions about our business that could affect our future results and could cause those results or other outcomes to differ materially from those expressed or implied in the forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in “Risk Factors” included in documents we file from time to time with the U.S. Securities and Exchange Commission (the SEC), including our Annual Report on Form 10-K for our fiscal year ended May 31, 2015 and our other Quarterly Reports on Form 10-Q filed by us in our fiscal year 2016, which runs from June 1, 2015 to May 31, 2016.

We have no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or risks, except to the extent required by applicable securities laws. If we do update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements. New information, future events or risks could cause the forward-looking events we discuss in this Quarterly Report not to occur. You should not place undue reliance on these forward-looking statements, which reflect our expectations only as of the date of this Quarterly Report.

 

2


Table of Contents

PART I. FINANCIAL INFORMATION

Item 1.    Financial Statements (Unaudited)

ORACLE CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

As of February 29, 2016 and May 31, 2015

(Unaudited)

 

(in millions, except per share data)

   February 29,
        2016       
    May 31,
        2015         
 
ASSETS     

Current assets:

    

Cash and cash equivalents

   $     15,583      $     21,716   

Marketable securities

     35,184        32,652   

Trade receivables, net of allowances for doubtful accounts of $314 and $285 as of February 29, 2016 and May 31, 2015, respectively

     3,844        5,618   

Inventories

     212        314   

Prepaid expenses and other current assets

     2,246        2,220   
  

 

 

   

 

 

 

Total current assets

     57,069        62,520   
  

 

 

   

 

 

 

Non-current assets:

    

Property, plant and equipment, net

     4,011        3,686   

Intangible assets, net

     5,249        6,406   

Goodwill, net

     34,284        34,087   

Deferred tax assets

     1,382        1,458   

Other assets

     2,899        2,746   
  

 

 

   

 

 

 

Total non-current assets

     47,825        48,383   
  

 

 

   

 

 

 

Total assets

   $ 104,894      $ 110,903   
  

 

 

   

 

 

 
LIABILITIES AND EQUITY     

Current liabilities:

    

Notes payable, current

   $      $ 1,999   

Accounts payable

     410        806   

Accrued compensation and related benefits

     1,536        1,839   

Deferred revenues

     6,912        7,245   

Other current liabilities

     2,967        3,317   
  

 

 

   

 

 

 

Total current liabilities

     11,825        15,206   
  

 

 

   

 

 

 

Non-current liabilities:

    

Notes payable, non-current

     40,106        39,959   

Income taxes payable

     4,418        4,386   

Other non-current liabilities

     2,209        2,254   
  

 

 

   

 

 

 

Total non-current liabilities

     46,733        46,599   
  

 

 

   

 

 

 

Commitments and contingencies

    

Oracle Corporation 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: 4,156 shares and 4,343 shares as of February 29, 2016 and May 31, 2015, respectively

     23,526        23,156   

Retained earnings

     23,390        26,503   

Accumulated other comprehensive loss

     (1,046     (996
  

 

 

   

 

 

 

Total Oracle Corporation stockholders’ equity

     45,870        48,663   

Noncontrolling interests

     466        435   
  

 

 

   

 

 

 

Total equity

     46,336        49,098   
  

 

 

   

 

 

 

Total liabilities and equity

   $ 104,894      $ 110,903   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

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ORACLE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

For the Three and Nine Months Ended February 29, 2016 and February 28, 2015

(Unaudited)

 

     Three Months Ended     Nine Months Ended  

(in millions, except per share data)

   February 29,
2016
    February 28,
2015
    February 29,
2016
    February 28,
2015
 

Revenues:

        

Cloud software as a service and platform as a service

   $     583      $     372      $     1,517      $     1,069   

Cloud infrastructure as a service

     152        155        477        448   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total cloud revenues

     735        527        1,994        1,517   
  

 

 

   

 

 

   

 

 

   

 

 

 

New software licenses

     1,680        1,982        4,509        5,397   

Software license updates and product support

     4,669        4,661        14,048        14,161   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total on-premise software revenues

     6,349        6,643        18,557        19,558   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total cloud and on-premise software revenues

     7,084        7,170        20,551        21,075   
  

 

 

   

 

 

   

 

 

   

 

 

 

Hardware products

     604        712        1,746        2,007   

Hardware support

     531        587        1,639        1,791   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total hardware revenues

     1,135        1,299        3,385        3,798   

Total services revenues

     793        858        2,517        2,647   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     9,012        9,327        26,453        27,520   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

Sales and marketing(1)

     1,903        1,839        5,578        5,443   

Cloud software as a service and platform as a service(1)

     292        203        847        517   

Cloud infrastructure as a service(1)

     88        88        268        254   

Software license updates and product support(1)

     293        300        877        867   

Hardware products(1)

     338        367        967        1,034   

Hardware support(1)

     171        218        526        628   

Services(1)

     657        724        2,058        2,179   

Research and development

     1,419        1,370        4,253        4,088   

General and administrative

     290        252        832        799   

Amortization of intangible assets

     408        527        1,283        1,642   

Acquisition related and other

     11        8        35        12   

Restructuring

     115        48        293        168   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     5,985        5,944        17,817        17,631   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     3,027        3,383        8,636        9,889   

Interest expense

     (360     (273     (1,105     (817

Non-operating income, net

     65        40        179        65   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before provision for income taxes

     2,732        3,150        7,710        9,137   

Provision for income taxes

     590        655        1,623        1,956   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 2,142      $ 2,495      $ 6,087      $ 7,181   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share:

        

Basic

   $ 0.51      $ 0.57      $ 1.43      $ 1.63   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 0.50      $ 0.56      $ 1.41      $ 1.59   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average common shares outstanding:

        

Basic

     4,182        4,389        4,246        4,419   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     4,256        4,494        4,328        4,516   
  

 

 

   

 

 

   

 

 

   

 

 

 

Dividends declared per common share

   $ 0.15      $ 0.12      $ 0.45      $ 0.36   
  

 

 

   

 

 

   

 

 

   

 

 

 

  

 

(1) 

Exclusive of amortization of intangible assets, which is shown separately.

See notes to condensed consolidated financial statements.

 

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ORACLE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

For the Three and Nine Months Ended February 29, 2016 and February 28, 2015

(Unaudited)

 

    Three Months Ended     Nine Months Ended  

(in millions)

  February 29,
2016
    February 28,
2015
    February 29,
2016
    February 28,
2015
 

Net income

  $ 2,142      $ 2,495      $ 6,087      $ 7,181   

Other comprehensive income (loss), net of tax:

       

Net foreign currency translation gains (losses)

    142        (262     9        (629

Net unrealized gains on defined benefit plans

    5        2        25        8   

Net unrealized gains (losses) on marketable securities

    69        (6     (47     15   

Net unrealized (losses) gains on cash flow hedges

    (23     (30     (37     6   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive income (loss), net

    193        (296     (50     (600
 

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

  $     2,335      $     2,199      $     6,037      $     6,581   
 

 

 

   

 

 

   

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

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ORACLE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Nine Months Ended February 29, 2016 and February 28, 2015

(Unaudited)

 

    Nine Months Ended  

(in millions)

  February 29,
     2016    
    February 28,
     2015    
 

Cash flows from operating activities:

   

Net income

  $ 6,087      $ 7,181   

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

   

Depreciation

    643        502   

Amortization of intangible assets

    1,283        1,642   

Deferred income taxes

    (143     (486

Stock-based compensation

    768        689   

Tax benefits on the exercise of stock options and vesting of restricted stock-based awards

    188        284   

Excess tax benefits on the exercise of stock options and vesting of restricted stock-based awards

    (61     (167

Other, net

    116        126   

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

   

Decrease in trade receivables, net

    1,746        1,867   

Decrease (increase) in inventories

    87        (78

Decrease in prepaid expenses and other assets

    95        362   

Decrease in accounts payable and other liabilities

    (890     (1,204

Decrease in income taxes payable

    (112     (369

Increase (decrease) in deferred revenues

    24        (296
 

 

 

   

 

 

 

Net cash provided by operating activities

    9,831        10,053   
 

 

 

   

 

 

 

Cash flows from investing activities:

   

Purchases of marketable securities and other investments

    (21,549     (23,339

Proceeds from maturities and sales of marketable securities and other investments

    18,845        15,042   

Acquisitions, net of cash acquired

    (313     (6,232

Capital expenditures

    (1,009     (794
 

 

 

   

 

 

 

Net cash used for investing activities

    (4,026     (15,323
 

 

 

   

 

 

 

Cash flows from financing activities:

   

Payments for repurchases of common stock

    (8,467     (6,079

Proceeds from issuances of common stock

    802        1,456   

Shares repurchased for tax withholdings upon vesting of restricted stock-based awards

    (82     (11

Payments of dividends to stockholders

    (1,918     (1,600

Proceeds from borrowings, net of issuance costs

           9,945   

Repayments of borrowings

    (2,000     (1,500

Excess tax benefits on the exercise of stock options and vesting of restricted stock-based awards

    61        167   

Distributions to noncontrolling interests

    (85     (196
 

 

 

   

 

 

 

Net cash (used for) provided by financing activities

    (11,689     2,182   
 

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents

    (249     (980
 

 

 

   

 

 

 

Net decrease in cash and cash equivalents

    (6,133     (4,068

Cash and cash equivalents at beginning of period

    21,716        17,769   
 

 

 

   

 

 

 

Cash and cash equivalents at end of period

  $ 15,583      $ 13,701   
 

 

 

   

 

 

 

Non-cash investing and financing transactions:

   

Fair value of stock options and restricted stock-based awards assumed in connection with acquisitions

  $      $ 12   

Increase in unsettled repurchases of common stock

  $ 3      $ 8   

(Decrease) increase in unsettled investment purchases

  $ (148   $ 817   

See notes to condensed consolidated financial statements.

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

February 29, 2016

(Unaudited)

 

1. BASIS OF PRESENTATION AND RECENT ACCOUNTING PRONOUNCEMENTS

Basis of Presentation

We have prepared the condensed consolidated financial statements included herein pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) have been condensed or omitted pursuant to such rules and regulations. However, we believe that the disclosures herein are adequate to ensure the information presented is not misleading. These unaudited condensed consolidated financial statements should be read in conjunction with the audited financial statements and the notes thereto included in our Annual Report on Form 10-K for the fiscal year ended May 31, 2015.

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, 2016. Certain prior year balances have been reclassified to conform to the current year presentation. Such reclassifications did not affect total revenues, operating income or net income.

During the first nine months of fiscal 2016, we adopted Accounting Standards Update (ASU) 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes (ASU 2015-17) on a retrospective basis. As required by ASU 2015-17, all deferred tax assets and liabilities are classified as non-current in our consolidated balance sheets, which is a change from our historical presentation whereby certain of our deferred tax assets and liabilities were classified as current and the remainder were classified as non-current. Upon adoption of ASU 2015-17, current deferred tax assets of $663 million and current deferred tax liabilities of $85 million in our May 31, 2015 consolidated balance sheet were reclassified as non-current.

In addition, during the first nine months of fiscal 2016, we also adopted ASU 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments, ASU 2015-15, Interest—Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements—Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting, ASU 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory, and ASU 2015-05, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement, none of which had a material impact on our reported financial position or results of operations and cash flows. There have been no other significant changes in our reported financial position or results of operations and cash flows as a result of the adoption of new accounting pronouncements or to our significant accounting policies that were disclosed in our Annual Report on Form 10-K for the fiscal year ended May 31, 2015 that have had a significant impact on our consolidated financial statements or notes thereto.

Acquisition Related and Other Expenses

Acquisition related and other expenses consist of personnel related costs for transitional and certain other employees, stock-based compensation expenses, integration related professional services, certain business combination adjustments including certain adjustments after the measurement period has ended and certain other operating items, net. Stock-based compensation expenses included in acquisition related and other expenses resulted from unvested stock options and restricted stock-based awards assumed from acquisitions whereby vesting was accelerated upon termination of the employees pursuant to the original terms of those stock options and restricted stock-based awards.

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 29, 2016

(Unaudited)

 

     Three Months Ended     Nine Months Ended  

(in millions)

   February 29,
     2016    
     February 28,
     2015    
    February 29,
     2016    
    February 28,
     2015    
 

Transitional and other employee related costs

   $ 8       $ 14      $ 40      $ 46   

Stock-based compensation

             1        3        5   

Professional fees and other, net

     1         (7     10        (39

Business combination adjustments, net

     2                (18       
  

 

 

    

 

 

   

 

 

   

 

 

 

Total acquisition related and other expenses

   $ 11       $ 8      $ 35      $ 12   
  

 

 

    

 

 

   

 

 

   

 

 

 

Included in acquisition related and other expenses during the nine months ended February 29, 2016 and February 28, 2015 were an acquisition related benefit of $19 million and a litigation related benefit of $53 million, respectively.

Non-Operating Income, net

Non-operating income, net consists primarily of interest income, net foreign currency exchange gains (losses), the noncontrolling interests in the net profits of our majority-owned subsidiaries (primarily Oracle Financial Services Software Limited and Oracle Japan) and net other income (losses), including net realized gains and losses related to all of our investments and net unrealized gains and losses related to the small portion of our investment portfolio that we classify as trading.

 

     Three Months Ended     Nine Months Ended  

(in millions)

   February 29,
     2016    
    February 28,
     2015    
    February 29,
     2016    
    February 28,
     2015    
 

Interest income

   $ 141      $ 82      $ 382      $ 250   

Foreign currency losses, net

     (15     (32     (68     (105

Noncontrolling interests in income

     (36     (17     (95     (100

Other (loss) income, net

     (25     7        (40     20   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-operating income, net

   $ 65      $ 40      $ 179      $ 65   
  

 

 

   

 

 

   

 

 

   

 

 

 

Sales of Financing Receivables

We offer certain of our customers the option to acquire our software products, hardware products and services offerings through separate long-term payment contracts. We generally sell these contracts that we have financed for our customers on a non-recourse basis to financial institutions within 90 days of the contracts’ dates of execution. We record the transfers of amounts due from customers to financial institutions as sales of financing receivables because we are considered to have surrendered control of these financing receivables. Financing receivables sold to financial institutions were $304 million and $1.5 billion for the three and nine months ended February 29, 2016, respectively, and $415 million and $1.3 billion for the three and nine months ended February 28, 2015, respectively.

Recent Accounting Pronouncements

Derivatives and Hedging:    In March 2016, the Financial Accounting Standards Board (FASB) issued ASU 2016-05, Derivatives and Hedging (Topic 815): Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships (ASU 2016-05) and ASU 2016-06, Derivatives and Hedging (Topic 815): Contingent Put and Call Options in Debt Instruments (ASU 2016-06). ASU 2016-05 clarifies that a change in the counterparty to a derivative instrument that has been designated as a hedging instrument does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria continue to be met. ASU 2016-06 clarifies the steps required to determine bifurcation of an embedded derivative. ASU 2016-05

 

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February 29, 2016

(Unaudited)

 

and ASU 2016-06 are effective for us in our first quarter of fiscal 2018 and earlier adoption is permitted. We are currently evaluating the impact of our pending adoptions of ASU 2016-05 and ASU 2016-06 on our consolidated financial statements.

Leases:    In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (ASU 2016-02). ASU 2016-02 requires companies to generally recognize on the balance sheet operating and financing lease liabilities and corresponding right-of-use assets. ASU 2016-02 is effective for us in our first quarter of fiscal 2020 on a modified retrospective basis and earlier adoption is permitted. We are currently evaluating the impact of our pending adoption of ASU 2016-02 on our consolidated financial statements and we currently expect that most of our operating lease commitments will be subject to the new standard and recognized as operating lease liabilities and right-of-use assets upon our adoption of ASU 2016-02.

Financial Instruments:    In January 2016, the FASB issued ASU 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (ASU 2016-01), which addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. ASU 2016-01 is effective for us in our first quarter of fiscal 2019 and earlier adoption is not permitted. We are currently evaluating the impact of our pending adoption of ASU 2016-01 on our consolidated financial statements.

Revenue Recognition:    In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers: Topic 606 (ASU 2014-09), to supersede nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, it is possible more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation, among others. The original effective date of ASU 2014-09 would have required us to adopt the standard in our first quarter of fiscal 2018. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date (ASU 2015-14), which defers the effective date by one year while providing the option to early adopt the standard on the original effective date. Accordingly, we may adopt the standard either in our first quarter of fiscal 2018 or our first quarter of fiscal 2019 using either of two methods: (i) retrospective application of ASU 2014-09 to each prior reporting period presented with the option to elect certain practical expedients as defined within ASU 2014-09; or (ii) retrospective application of ASU 2014-09 with the cumulative effect of initially applying ASU 2014-09 recognized at the date of initial application and providing certain additional disclosures as defined per ASU 2014-09. We are currently evaluating the timing and the impact of our pending adoption of ASU 2014-09 on our consolidated financial statements.

 

2. ACQUISITIONS

Fiscal 2016 Acquisitions

During the first nine months of fiscal 2016, we acquired certain companies and purchased certain technology and development assets primarily to expand our products and services offerings. These acquisitions were not significant individually or in the aggregate. We also acquired one company during the fourth quarter of fiscal 2016 which was not significant.

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 29, 2016

(Unaudited)

 

Fiscal 2015 Acquisitions

Acquisition of MICROS Systems, Inc.

On June 22, 2014, we entered into an Agreement and Plan of Merger (Merger Agreement) with MICROS Systems, Inc. (MICROS), a provider of integrated software, hardware and services solutions to the hospitality and retail industries. On July 3, 2014, pursuant to the Merger Agreement, we commenced a tender offer to purchase all of the issued and outstanding shares of common stock of MICROS at a purchase price of $68.00 per share, net to the holder in cash, without interest thereon, based upon the terms and subject to the conditions set forth in the Merger Agreement. Between September 3, 2014 and September 8, 2014, pursuant to the terms of the tender offer, we accepted and paid for the substantial majority of outstanding shares of MICROS common stock. On September 8, 2014, we effectuated the merger of MICROS with and into a wholly-owned subsidiary of Oracle pursuant to the terms of the Merger Agreement and applicable Maryland law, and MICROS became an indirect, wholly-owned subsidiary of Oracle. Pursuant to the merger, shares of MICROS common stock that remained outstanding and were not acquired by us were converted into, and cancelled in exchange for, the right to receive $68.00 per share in cash. The unvested equity awards to acquire MICROS common stock that were outstanding immediately prior to the conclusion of the merger were converted into equity awards denominated in shares of Oracle common stock based on formulas contained in the Merger Agreement. We acquired MICROS to, among other things, expand our cloud and on-premise software, hardware and related services offerings for hotels, food and beverage industries, facilities, and retailers. We have included the financial results of MICROS in our consolidated financial statements from the date of acquisition.

Pursuant to our business combinations accounting policy, we estimated the fair values of net tangible and intangible assets acquired and the excess of the consideration transferred over the aggregate of such fair values was recorded as goodwill. The following table summarizes the estimated fair values of net assets acquired from MICROS:

 

(in millions)

      

Cash and cash equivalents

   $ 683   

Trade receivables, net

     181   

Inventories

     28   

Goodwill

     3,242   

Intangible assets

     2,030   

Other assets

     155   

Accounts payable and other liabilities

     (359

Deferred tax liabilities, net

     (536

Deferred revenues

     (177
  

 

 

 

Total

   $     5,247   
  

 

 

 

We do not expect the goodwill recognized as a part of the MICROS acquisition to be deductible for income tax purposes.

Other Fiscal 2015 Acquisitions

During fiscal 2015, we acquired certain other companies and purchased certain technology and development assets primarily to expand our products and services offerings. These acquisitions were not individually significant. We have included the financial results of the acquired companies in our consolidated financial statements from their respective acquisition dates and the results from each of these companies were not individually material to our consolidated financial statements. In the aggregate, the total purchase price for these acquisitions was approximately $1.7 billion, which consisted of approximately $1.7 billion in cash and $7 million for the fair values of stock options and restricted stock-based awards assumed. We recorded $6 million of net tangible liabilities and $388 million of identifiable intangible assets, based on their estimated fair values, and $1.4 billion of residual goodwill.

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 29, 2016

(Unaudited)

 

Unaudited Pro Forma Financial Information

The unaudited pro forma financial information in the table below summarizes the combined results of operations for Oracle, MICROS, and certain other companies that we acquired since the beginning of fiscal 2015 that were considered relevant for the purposes of unaudited pro forma financial information disclosure as if the companies were combined as of the beginning of fiscal 2015. The unaudited pro forma financial information for all periods presented also included the business combination accounting effects resulting from these acquisitions, including amortization charges from acquired intangible assets (certain of which are preliminary), stock-based compensation charges for unvested stock options and restricted stock-based awards assumed, if any, and the related tax effects as though the aforementioned companies were combined as of the beginning of fiscal 2015. The unaudited pro forma financial information as presented below is for informational purposes only and is not necessarily indicative of the results of operations that would have been achieved if the acquisitions had taken place at the beginning of fiscal 2015.

The unaudited pro forma financial information for the three and nine months ended February 29, 2016 combined the historical results of Oracle for the three and nine months ended February 29, 2016 and the historical results of certain other companies that we acquired since the beginning of fiscal 2016 based upon their respective previous reporting periods and the dates these companies were acquired by us, and the effects of the pro forma adjustments listed above.

The unaudited pro forma financial information for the three and nine months ended February 28, 2015 combined the historical results of Oracle for the three and nine months ended February 28, 2015, the historical results of MICROS for the three and six months ended June 30, 2014 (adjusted due to differences in reporting periods and considering the date we acquired MICROS), and the historical results of certain other companies that we acquired since the beginning of fiscal 2015 based upon their respective previous reporting periods and the dates these companies were acquired by us, and the effects of the pro forma adjustments listed above. The unaudited pro forma financial information was as follows:

 

     Three Months Ended      Nine Months Ended  

(in millions, except per share data)

   February 29,
2016
     February 28,
2015
     February 29,
2016
     February 28,
2015
 

Total revenues

   $       9,017       $ 9,364       $       26,486       $ 28,045   

Net income

   $ 2,137       $ 2,455       $ 6,078       $ 7,114   

Basic earnings per share

   $ 0.51       $ 0.56       $ 1.43       $ 1.61   

Diluted earnings per share

   $ 0.50       $       0.55       $ 1.40       $       1.58   

 

3. FAIR VALUE MEASUREMENTS

We perform fair value measurements in accordance with the FASB Accounting Standards Codification (ASC) 820, Fair Value Measurement. ASC 820 defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required to be recorded at their fair values, we consider the principal or most advantageous market in which we would transact and consider assumptions that market participants would use when pricing the assets or liabilities, such as inherent risk, transfer restrictions and risk of nonperformance.

ASC 820 establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. An asset’s or a liability’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. ASC 820 establishes three levels of inputs that may be used to measure fair value:

 

   

Level 1: quoted prices in active markets for identical assets or liabilities;

 

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February 29, 2016

(Unaudited)

 

   

Level 2: inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; or

 

   

Level 3: unobservable inputs that are supported by little or no market activity and that are significant to the fair values of the assets or liabilities.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

Our assets and liabilities measured at fair value on a recurring basis, excluding accrued interest components, consisted of the following (Level 1 and 2 inputs are defined above):

 

    February 29, 2016     May 31, 2015  
    Fair Value  Measurements
Using Input Types
          Fair Value  Measurements
Using Input Types
       

(in millions)

      Level 1             Level 2             Total             Level 1             Level 2             Total      

Assets:

           

U.S. Treasury securities

  $ 115      $      $ 115      $ 668      $      $ 668   

Commercial paper debt securities

           2,609        2,609               9,203        9,203   

Corporate debt securities and other

    192        34,535        34,727        190        28,654        28,844   

Derivative financial instruments

           164        164               74        74   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

  $ 307      $ 37,308      $ 37,615      $ 858      $ 37,931      $ 38,789   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities:

           

Derivative financial instruments

  $      $ 260      $ 260      $      $ 244      $ 244   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Our marketable securities investments consist of Tier 1 commercial paper debt securities, corporate debt securities and certain other securities. As of February 29, 2016 and May 31, 2015, approximately 21% and 28%, respectively, of our marketable securities investments mature within one year and 79% and 72%, respectively, mature within one to six years. Our valuation techniques used to measure the fair values of our marketable securities that were classified as Level 1 in the table above were derived from quoted market prices and active markets for these instruments exist. Our valuation techniques used to measure the fair values of Level 2 instruments listed in the table above, the counterparties to which have high credit ratings, were derived from the following: non-binding market consensus prices that were corroborated by observable market data, quoted market prices for similar instruments, or pricing models, such as discounted cash flow techniques, with all significant inputs derived from or corroborated by observable market data including LIBOR-based yield curves, among others.

Based on the trading prices of our $40.1 billion and $42.0 billion of senior notes that were outstanding as of February 29, 2016 and May 31, 2015, respectively, the estimated fair values of our borrowings using Level 2 inputs at February 29, 2016 and May 31, 2015 were $42.2 billion and $44.1 billion, respectively.

 

4. INVENTORIES

Inventories consisted of the following:

 

(in millions)

   February 29,
         2016        
     May 31,
         2015        
 

Raw materials

   $ 102       $ 112   

Work-in-process

     23         38   

Finished goods

     87         164   
  

 

 

    

 

 

 

Total

   $ 212       $ 314   
  

 

 

    

 

 

 

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 29, 2016

(Unaudited)

 

5. INTANGIBLE ASSETS AND GOODWILL

The changes in intangible assets for fiscal 2016 and the net book value of intangible assets as of February 29, 2016 and May 31, 2015 were as follows:

 

    Intangible Assets, Gross     Accumulated Amortization     Intangible Assets, Net     Weighted
Average

Useful  Life(1)

(Dollars in millions)

  May 31,
2015
    Additions     February  29,
2016
    May 31,
2015
    Expense     February  29,
2016
    May 31,
2015
    February  29,
2016
   

Software support agreements and related relationships

  $ 4,190      $      $ 4,190      $ (2,700   $ (297   $ (2,997   $ 1,490      $ 1,193      N.A

Hardware support agreements and related relationships

    1,012               1,012        (654     (109     (763     358        249      N.A

Developed technology

    4,602        55        4,657        (2,355     (427     (2,782     2,247        1,875      5 years

Core technology

    552               552        (411     (70     (481     141        71      N.A

Customer relationships and contract backlog

    2,197        8        2,205        (1,710     (177     (1,887     487        318      3 years

SaaS, PaaS and IaaS agreements and related relationships and other

    1,993        57        2,050        (508     (160     (668     1,485        1,382      10 years

Trademarks

    501        6        507        (303     (43     (346     198        161      5 years
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Total intangible assets, net

  $ 15,047      $ 126      $ 15,173      $ (8,641   $ (1,283   $ (9,924   $ 6,406      $ 5,249      7 years
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

(1) 

Represents weighted average useful lives of intangible assets acquired during fiscal 2016.

Total amortization expense related to our intangible assets was $408 million and $1.3 billion for the three and nine months ended February 29, 2016, respectively, and $527 million and $1.6 billion for the three and nine months ended February 28, 2015, respectively. As of February 29, 2016, estimated future amortization expenses related to intangible assets were as follows (in millions):

 

Remainder of fiscal 2016

   $ 353   

Fiscal 2017

     1,016   

Fiscal 2018

     867   

Fiscal 2019

     760   

Fiscal 2020

     615   

Fiscal 2021

     470   

Thereafter

     1,168   
  

 

 

 

Total intangible assets, net

   $     5,249   
  

 

 

 

The changes in the carrying amounts of goodwill, which is generally not deductible for tax purposes, for our operating segments for the nine months ended February 29, 2016 were as follows:

 

(in millions)

   Cloud
Software  and

On-Premise
Software
     Software
License
Updates and
Product
Support
    Hardware
Support
    Consulting      Other(2)     Total  

Balances as of May 31, 2015

   $ 15,217       $ 14,461      $     2,370      $     1,759       $ 280      $     34,087   

Goodwill from acquisitions

     211                                      211   

Goodwill adjustments, net(1)

     12         (21     (3             (2     (14
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Balances as of February 29, 2016

   $ 15,440       $ 14,440      $     2,367      $ 1,759       $     278      $ 34,284   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

(1) 

Pursuant to our business combinations accounting policy, we recorded goodwill adjustments for the effects on goodwill of changes to net assets acquired during the period that such a change is identified, provided that any such change is within the measurement period (up to one year from the date of the acquisition).

 

(2) 

Represents goodwill allocated to our other operating segments.

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 29, 2016

(Unaudited)

 

6. RESTRUCTURING ACTIVITIES

Fiscal 2015 Oracle Restructuring Plan

During the second quarter of fiscal 2015, our management approved, committed to and initiated plans to restructure and further improve efficiencies in our operations due to our acquisition of MICROS and certain other operational activities (2015 Restructuring Plan). The total estimated restructuring costs associated with the 2015 Restructuring Plan are up to $525 million and will be recorded to the restructuring expense line item within our consolidated statements of operations as they are incurred. We recorded $300 million of restructuring expenses in connection with the 2015 Restructuring Plan in the first nine months of fiscal 2016 and we expect to incur the majority of the estimated remaining $125 million through the end of fiscal 2016. Any changes to the estimates of executing the 2015 Restructuring Plan will be reflected in our future results of operations.

Summary of All Plans

 

(in millions)

 

Accrued

    Nine Months Ended February 29, 2016    

Accrued

   

Total
Costs

   

Total
Expected

 
  May 31,
2015(2)
    Initial
Costs(3)
    Adj. to
Cost(4)
    Cash
Payments
    Others(5)     February 29,
2016(2)
    Accrued
to Date
    Program
Costs
 

Fiscal 2015 Oracle Restructuring Plan(1)

               

Cloud software and on-premise software

  $ 11      $ 59      $ (6   $ (51   $ 2      $ 15      $ 80      $ 93   

Software license updates and product support

    5        118        (1     (35            87        124        175   

Hardware business

    6        46        (6     (32     2        16        60        64   

Services business

    9        28        (4     (25            8        45        85   

General and administrative and other

    5        64        2        (42     (2     27        91        108   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Fiscal 2015 Oracle Restructuring Plan

  $ 36      $ 315      $ (15   $ (185   $ 2      $ 153      $ 400      $ 525   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other restructuring plans(6)

  $ 84      $ 1      $ (8   $ (21   $ (8   $ 48       
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

     

Total restructuring plans

  $ 120      $ 316      $ (23   $ (206   $ (6   $ 201       
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

     

 

 

(1)

Restructuring costs recorded for individual line items primarily related to employee severance costs.

 

(2)

The balances at February 29, 2016 and May 31, 2015 included $173 million and $86 million, respectively, recorded in other current liabilities, and $28 million and $34 million, respectively, recorded in other non-current liabilities.

 

(3)

Costs recorded for the respective restructuring plans during the current period presented.

 

(4)

All plan adjustments were changes in estimates whereby increases and decreases in costs were generally recorded to operating expenses in the period of adjustments.

 

(5)

Represents foreign currency translation and certain other adjustments.

 

(6)

Other restructuring plans presented in the table above included condensed information for other Oracle-based plans and other plans associated with certain of our acquisitions whereby we continued to make cash outlays to settle obligations under these plans during the period presented but for which the current impact to our condensed consolidated statements of operations was not significant.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 29, 2016

(Unaudited)

 

7. DEFERRED REVENUES

Deferred revenues consisted of the following:

 

(in millions)

   February 29,
2016
     May 31,
2015
 

Software license updates and product support

   $ 5,239       $     5,635   

Cloud SaaS, PaaS and IaaS

     642         404   

Hardware support and other

     618         703   

Services

     322         379   

New software licenses

     91         124   
  

 

 

    

 

 

 

Deferred revenues, current

     6,912         7,245   

Deferred revenues, non-current (in other non-current liabilities)

     485         393   
  

 

 

    

 

 

 

Total deferred revenues

   $ 7,397       $ 7,638   
  

 

 

    

 

 

 

Deferred software license updates and product support revenues and deferred hardware support revenues represent customer payments made in advance for support contracts that are typically billed on a per annum basis in advance with corresponding revenues being recognized ratably over the support periods. Deferred cloud software as a service (SaaS), platform as a service (PaaS) and infrastructure as a service (IaaS) revenues generally result from customer payments made in advance for our cloud-based offerings that are recognized over the corresponding contractual term. Deferred services revenues include prepayments for our services business and revenues for these services are generally recognized as the services are performed. Deferred new software licenses revenues typically result from undelivered products or specified enhancements, customer specific acceptance provisions, customer payments made in advance for time-based license arrangements and software license transactions that cannot be separated from undelivered consulting or other services.

In connection with our acquisitions, we have estimated the fair values of the cloud SaaS and PaaS, software license updates and product support, and hardware support obligations, among others, assumed from our acquired companies. We generally have estimated the fair values of these obligations assumed using 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 sum of the costs and operating profit approximates, in theory, the amount that we would be required to pay a third party to assume these acquired obligations. These aforementioned fair value adjustments recorded for obligations assumed from our acquisitions reduced the cloud SaaS and PaaS, software license updates and product support and hardware support deferred revenues balances that we recorded as liabilities from these acquisitions and also reduced the resulting revenues that we recognized or will recognize over the terms of the acquired obligations during the post-combination periods.

 

8. DERIVATIVE FINANCIAL INSTRUMENTS

Fair Value HedgesInterest Rate Swap Agreements

In July 2014, we entered into certain interest rate swap agreements that have the economic effect of modifying the fixed interest obligations associated with our $2.0 billion of 2.25% senior notes due October 2019 (2019 Notes) and our $1.5 billion of 2.80% senior notes due July 2021 (2021 Notes) so that the interest payable on these senior notes effectively became variable based on LIBOR. In July 2013, we entered into certain interest rate swap agreements that have the economic effect of modifying the fixed interest obligations associated with our $1.5 billion of 2.375% senior notes due January 2019 (January 2019 Notes) so that the interest payable on these senior notes effectively became variable based on LIBOR. The critical terms of the interest rate swap agreements match the critical terms of the 2019 Notes, 2021 Notes and the January 2019 Notes that the interest rate swap agreements pertain to, including the notional amounts and maturity dates.

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 29, 2016

(Unaudited)

 

We have designated the aforementioned interest rate swap agreements as qualifying hedging instruments and are accounting for them as fair value hedges pursuant to ASC 815, Derivatives and Hedging (ASC 815). These transactions are characterized as fair value hedges for financial accounting purposes because they protect us against changes in the fair values of certain of our fixed-rate borrowings due to benchmark interest rate movements. The changes in fair values of these interest rate swap agreements are recognized as interest expense in our consolidated statements of operations with the corresponding amounts included in other assets or other non-current liabilities in our consolidated balance sheets. The amount of net gain (loss) attributable to the risk being hedged is recognized as interest expense in our consolidated statements of operations with the corresponding amount included in notes payable, non-current. The periodic interest settlements for the interest rate swap agreements for the 2019 Notes, 2021 Notes and the January 2019 Notes are recorded as interest expense and are included as a part of cash flows from operating activities.

We do not use any interest rate swap agreements for trading purposes.

Cash Flow HedgesCross-Currency Swap Agreements

In connection with the issuance of our €1.25 billion of 2.25% senior notes due January 2021 (January 2021 Notes), we entered into certain cross-currency swap agreements to manage the related foreign currency exchange risk by effectively converting the fixed-rate, Euro-denominated January 2021 Notes, including the annual interest payments and the payment of principal at maturity, to fixed-rate, U.S. Dollar-denominated debt. The economic effect of the swap agreements was to eliminate the uncertainty of the cash flows in U.S. Dollars associated with the January 2021 Notes by fixing the principal amount of the January 2021 Notes at $1.6 billion with a fixed annual interest rate of 3.53%. We have designated these cross-currency swap agreements as qualifying hedging instruments and are accounting for these as cash flow hedges pursuant to ASC 815. The critical terms of the cross-currency swap agreements correspond to the January 2021 Notes, including the annual interest payments being hedged, and the cross-currency swap agreements mature at the same time as the January 2021 Notes.

We used the hypothetical derivative method to measure the effectiveness of our cross-currency swap agreements. The fair values of these cross-currency swap agreements are recognized as other assets or other non-current liabilities in our consolidated balance sheets. The effective portions of the changes in fair values of these cross-currency swap agreements are reported in accumulated other comprehensive loss in our consolidated balance sheets and an amount is reclassified out of accumulated other comprehensive loss into non-operating income, net in the same period that the carrying value of the Euro-denominated January 2021 Notes are remeasured and the interest expense is recognized. The ineffective portion of the unrealized gains and losses on these cross-currency swaps, if any, is recorded immediately to non-operating income, net. We evaluate the effectiveness of our cross-currency swap agreements on a quarterly basis. We did not record any ineffectiveness for the nine months ended February 29, 2016 or February 28, 2015. The cash flows related to the cross-currency swap agreements that pertain to the periodic interest settlements are classified as operating activities and the cash flows that pertain to the principal balance are classified as financing activities.

We do not use any cross-currency swap agreements for trading purposes.

Net Investment HedgeForeign Currency Borrowings

In July 2013, we designated our €750 million of 3.125% senior notes due July 2025 (2025 Notes) as a net investment hedge of our investments in certain of our international subsidiaries that use the Euro as their functional currency in order to reduce the volatility in stockholders’ equity caused by the changes in foreign currency exchange rates of the Euro with respect to the U.S. Dollar.

We used the spot method to measure the effectiveness of our net investment hedge. Under this method, for each reporting period, the change in the carrying value of the Euro-denominated 2025 Notes due to remeasurement of

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 29, 2016

(Unaudited)

 

the effective portion is reported in accumulated other comprehensive loss in our consolidated balance sheet and the remaining change in the carrying value of the ineffective portion, if any, is recognized in non-operating income, net in our consolidated statements of operations. We evaluate the effectiveness of our net investment hedge at the beginning of every quarter. We did not record any ineffectiveness for the nine months ended February 29, 2016 or February 28, 2015.

Foreign Currency Forward Contracts Not Designated as Hedges

We transact business in various foreign currencies and have established a program that primarily utilizes foreign currency forward contracts to offset the risks associated with the effects of certain foreign currency exposures. We neither use these foreign currency forward contracts for trading purposes nor do we designate these forward contracts as hedging instruments pursuant to ASC 815 (refer to Note 11 of Notes to Consolidated Financial Statements as included in our Annual Report on Form 10-K for the fiscal year ended May 31, 2015 for additional information regarding these contracts). As of February 29, 2016 and May 31, 2015, respectively, the notional amounts of the forward contracts we held to purchase U.S. Dollars in exchange for other major international currencies were $2.1 billion and $2.2 billion, respectively. The notional amount of forward contracts we held to sell U.S. Dollars in exchange for other major international currencies was $1.2 billion as of both February 29, 2016 and May 31, 2015. The fair values of our outstanding foreign currency forward contracts were nominal as of February 29, 2016 and May 31, 2015. Included in our non-operating income, net were $93 million and $163 million of net gains related to these forward contracts for the three and nine months ended February 29, 2016, respectively, and $14 million and $49 million of net gains for the three and nine months ended February 28, 2015, respectively. The cash flows related to these foreign currency contracts are classified as operating activities.

The effects of derivative and non-derivative instruments designated as hedges on certain of our consolidated financial statements were as follows as of or for each of the respective periods presented below (amounts presented exclude any income tax effects):

Fair Values of Derivative and Non-Derivative Instruments Designated as Hedges in Condensed Consolidated Balance Sheets

 

        Fair Value  

(in millions)

 

Balance Sheet Location

  February 29,
2016
         May 31,     
2015
 

Interest rate swap agreements designated as fair value hedges

 

Other assets

  $ 164      $ 74   
   

 

 

   

 

 

 

Cross-currency swap agreements designated as cash flow hedges

 

Other non-current liabilities

  $ (260   $ (244
   

 

 

   

 

 

 

Foreign currency borrowings designated as net investment hedge

 

Notes payable, non-current

  $ (969   $ (981
   

 

 

   

 

 

 

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 29, 2016

(Unaudited)

 

Effects of Derivative and Non-Derivative Instruments Designated as Hedges on Income and Other Comprehensive Income (OCI) or Loss (OCL)

 

    Amount of Gain (Loss) Recognized in
Accumulated OCI or OCL (Effective Portion)
   

Location and Amount of Gain (Loss) Reclassified from

Accumulated OCI or OCL into Income (Effective Portion)

 
    Three Months Ended     Nine Months Ended         Three Months Ended     Nine Months Ended  

(in millions)

  February 29,
    2016    
    February 28,
    2015    
    February 29,
    2016    
    February 28,
    2015    
        February 29,
    2016    
    February 28,
    2015    
    February 29,
    2016    
    February 28,
    2015    
 

Cross-currency swap agreements designated as cash flow hedges

  $ 29      $ (164   $ (16   $ (277  

Non-operating income, net

  $ 52      $ (134   $ 21      $ (283
 

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

   

 

 

 

Foreign currency borrowings designated as net investment hedge

  $ (31   $ 80      $ (13   $ 169     

Not applicable

  $      $      $      $   
 

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

   

 

 

 

 

   

Location and Amount of Gain

Recognized in Income on Derivative

   

Location and Amount of Loss on Hedged Item

Recognized in Income Attributable to Risk Being Hedged

 
        Three Months Ended     Nine Months Ended         Three Months Ended     Nine Months Ended  

(in millions)

      February 29,
    2016    
    February 28,
    2015    
    February 29,
    2016    
    February 28,
    2015    
        February 29,
    2016    
    February 28,
    2015    
    February 29,
    2016    
    February 28,
    2015    
 

Interest rate swap agreements designated as fair value hedges

 

Interest expense  

  $ 76      $ 15      $ 90      $ 37     

Interest expense  

  $ (76   $ (15   $ (90   $ (37
   

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

   

 

 

 

 

9. STOCKHOLDERS’ EQUITY

Common Stock Repurchases

Our Board of Directors has approved a program for us to repurchase shares of our common stock. On March 15, 2016, we announced that our Board of Directors approved an expansion of our stock repurchase program by an additional $10.0 billion. As of February 29, 2016, approximately $809 million remained available for stock repurchases pursuant to our stock repurchase program prior to the March 2016 program expansion. We repurchased 222.7 million shares for $8.4 billion during the nine months ended February 29, 2016 (including 2.7 million shares for $98 million that were repurchased but not settled) and 147.7 million shares for $6.1 billion during the nine months ended February 28, 2015 under the stock repurchase program.

Our stock repurchase authorization does not have an expiration date and the pace of our repurchase activity will depend on factors such as our working capital needs, our cash requirements for acquisitions and dividend payments, our debt repayment obligations or repurchases of our debt, our stock price, and economic and market conditions. Our stock repurchases may be effected from time to time through open market purchases or pursuant to a Rule 10b5-1 plan. Our stock repurchase program may be accelerated, suspended, delayed or discontinued at any time.

Dividends on Common Stock

During the nine months ended February 29, 2016, our Board of Directors declared cash dividends of $0.45 per share of our outstanding common stock, which we paid during the same period.

In March 2016, our Board of Directors declared a quarterly cash dividend of $0.15 per share of our outstanding common stock. The dividend is payable on April 28, 2016 to stockholders of record as of the close of business on April 14, 2016. Future declarations of dividends and the establishment of future record and payment dates are subject to the final determination of our Board of Directors.

Stock-Based Compensation Expense and Valuations of Stock Awards

During the first nine months of fiscal 2016, we issued 24 million stock options and 32 million restricted stock-based awards (consisting of 30 million service-based restricted stock units (RSUs) and 2 million performance-based restricted stock units (PSUs)). Substantially all of the awards were issued as a part of our annual stock-based award process and are subject to

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 29, 2016

(Unaudited)

 

service-based vesting restrictions, with the PSUs also having performance-based vesting restrictions, that are of a similar nature to those described in Note 14 of Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended May 31, 2015. Approximately 7 million of the 24 million stock options granted during the first nine months of fiscal 2016 were to our Chief Executive Officers and Chief Technology Officer and had contractual lives of five years versus the 10-year contractual lives for the other stock options granted. Our 2016 stock-based award issuances were partially offset by forfeitures and cancellations of 11 million shares during the first nine months of fiscal 2016.

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

 

     Three Months Ended      Nine Months Ended  

(in millions)

   February 29,
     2016    
     February 28,
     2015    
     February 29,
     2016    
     February 28,
     2015    
 

Sales and marketing

   $ 57       $ 45       $ 163       $ 131   

Cloud software as a service and platform as a service

     4         3         13         8   

Cloud infrastructure as a service

     1         1         3         3   

Software license updates and product support

     6         6         18         15   

Hardware products

     1         1         4         4   

Hardware support

     1         2         4         4   

Services

     7         8         22         23   

Research and development

     154         138         452         380   

General and administrative

     29         29         86         116   

Acquisition related and other

             1         3         5   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total stock-based compensation

   $ 260       $ 234       $ 768       $ 689   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

10. INCOME TAXES

The effective tax rate for the periods presented is the result of the mix of income earned in various tax jurisdictions that apply a broad range of income tax rates. Our provision for income taxes differs from the tax computed at the U.S. federal statutory income tax rate due primarily to certain earnings considered as indefinitely reinvested in foreign operations, state taxes, the U.S. research and development tax credit, settlements with tax authorities and the U.S. domestic production activity deduction. Our effective tax rate was 21.6% and 21.0% for the three and nine months ended February 29, 2016, respectively, and 20.8% and 21.4% for the three and nine months ended February 28, 2015, respectively.

Our net deferred tax assets were $1.2 billion and $993 million as of February 29, 2016 and May 31, 2015, respectively. We believe it is more likely than not that the net deferred tax assets will be realized in the foreseeable future. Realization of our net deferred tax assets is dependent upon our generation of sufficient taxable income in future years in appropriate tax jurisdictions to obtain benefit from the reversal of temporary differences, net operating loss carryforwards and tax credit carryforwards. The amount of net deferred tax assets considered realizable is subject to adjustment in future periods if estimates of future taxable income change.

Domestically, U.S. federal and state taxing authorities are currently examining income tax returns of Oracle and various acquired entities for years through fiscal 2014. Our U.S. federal and, with some exceptions, our state income tax returns have been examined for all years prior to fiscal 2006 and we are no longer subject to audit for those periods.

Internationally, tax authorities for numerous non-U.S. jurisdictions are also examining returns affecting our unrecognized tax benefits. With some exceptions, we are generally no longer subject to tax examinations in non-U.S. jurisdictions for years prior to fiscal 1997.

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 29, 2016

(Unaudited)

 

We believe that we have adequately provided under U.S. GAAP for outcomes related to our tax audits. However, there can be no assurances as to the possible outcomes or any related financial statement effect thereof. On July 27, 2015, in Altera Corp. v. Commissioner, the U.S. Tax Court issued an opinion related to the treatment of stock-based compensation expense in an intercompany cost-sharing arrangement. A final decision has yet to be issued by the Tax Court due to other outstanding issues related to the case. At this time, the U.S. Department of the Treasury has not withdrawn the requirement to include stock-based compensation from its regulations. We have reviewed this case and its impact on Oracle and concluded that no adjustment to the consolidated financial statements is appropriate at this time. We will continue to monitor ongoing developments and potential impacts to our consolidated financial statements.

 

11. SEGMENT INFORMATION

ASC 280, Segment Reporting, 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 makers are our Chief Executive Officers. We are organized geographically and by line of business. While our Chief Executive Officers evaluate 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 three businesses—cloud and on-premise software, hardware and services—which are further divided into certain operating segments. Our cloud and on-premise software business is comprised of three operating segments: (1) cloud software and on-premise software, which includes our cloud SaaS and PaaS offerings, (2) cloud infrastructure as a service and (3) software license updates and product support. Our hardware business is comprised of two operating segments: (1) hardware products and (2) hardware support. All other operating segments are combined under our services business.

Our cloud software and on-premise software line of business markets, sells and delivers our application and platform technologies, including our SaaS and PaaS offerings, which provide customers a choice of software applications and platforms that are delivered via a cloud-based IT environment that we host, manage and support, and the licensing of our software products including Oracle Applications, Oracle Database, Oracle Fusion Middleware and Java, among others.

The cloud infrastructure as a service line of business provides comprehensive software and hardware management and maintenance services for customer IT infrastructure for a fee for a stated term that is hosted at our data center facilities, select partner data centers or physically on-premise at customer facilities; and deployment and management offerings for our software and hardware and related IT infrastructure including virtual machine instances that are subscription-based and designed for computing and reliable and secure object storage.

The software license updates and product support line of business generates revenues through the sale of software support contracts relating to on-premise new software licenses purchased by our customers. The software license updates and product support line of business provides our on-premise software customers with rights to software product upgrades and maintenance releases, patches released, internet access to technical content, as well as internet and telephone access to technical support personnel during the support period.

The hardware line of business provides Oracle Engineered Systems, servers, storage, networking, industry specific hardware, virtualization software, operating systems including the Oracle Solaris Operating System and management software to support diverse IT environments, including cloud computing environments.

Our hardware support line of business provides customers with software updates for the software components that are essential to the functionality of our hardware products, such as Oracle Solaris and certain other software products, and can include product repairs, maintenance services and technical support services.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 29, 2016

(Unaudited)

 

Our services business is comprised of the remainder of our operating segments and offers consulting, advanced customer support services and education services. Our consulting line of business primarily provides services to customers in business and IT strategy alignment, enterprise architecture planning and design, initial product implementation and integration and ongoing product enhancements and upgrades. Advanced customer support provides support services, both on-premise and remote, to our customers to enable increased performance and higher availability of their products and services and also includes certain other services. Education services provide training to customers, partners and employees as a part of our mission of accelerating the adoption and use of our software and hardware products and to create opportunities to grow our product revenues.

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

The following table presents summary results for each of our three businesses and for the operating segments of our cloud and on-premise software and hardware businesses:

 

    Three Months Ended     Nine Months Ended  

(in millions)

  February 29,
2016
    February 28,
2015
    February 29,
2016
    February 28,
2015
 

Cloud software and on-premise software:

       

Revenues(1)

  $ 2,265      $ 2,356      $ 6,030      $ 6,469   

Cloud software as a service and platform as a service expenses

    284        195        822        494   

Sales and distribution expenses

    1,469        1,390        4,224        4,106   
 

 

 

   

 

 

   

 

 

   

 

 

 

Margin(2)

  $ 512      $ 771      $ 984      $ 1,869   

Cloud infrastructure as a service:

       

Revenues

  $ 152      $ 155      $ 477      $ 448   

Cloud infrastructure as a service expenses

    84        84        256        242   

Sales and distribution expenses

    17        25        54        65   
 

 

 

   

 

 

   

 

 

   

 

 

 

Margin(2)

  $ 51      $ 46      $ 167      $ 141   

Software license updates and product support:

       

Revenues(1)

  $ 4,669      $ 4,664      $ 14,049      $ 14,170   

Software license updates and product support expenses

    276        281        823        820   
 

 

 

   

 

 

   

 

 

   

 

 

 

Margin(2)

  $ 4,393      $ 4,383      $ 13,226      $ 13,350   

Total cloud and on-premise software business:

       

Revenues(1)

  $ 7,086      $ 7,175      $ 20,556      $ 21,087   

Expenses

    2,130        1,975        6,179        5,727   
 

 

 

   

 

 

   

 

 

   

 

 

 

Margin(2)

  $ 4,956      $ 5,200      $ 14,377      $ 15,360   

Hardware products:

       

Revenues

  $ 604      $ 712      $ 1,746      $ 2,007   

Hardware products expenses

    337        366        963        1,030   

Sales and distribution expenses

    197        211        614        632   
 

 

 

   

 

 

   

 

 

   

 

 

 

Margin(2)

  $ 70      $ 135      $ 169      $ 345   

Hardware support:

       

Revenues(1)

  $ 531      $ 588      $ 1,640      $ 1,794   

Hardware support expenses

    165        209        504        602   
 

 

 

   

 

 

   

 

 

   

 

 

 

Margin(2)

  $ 366      $ 379      $ 1,136      $ 1,192   

Total hardware business:

       

Revenues(1)

  $ 1,135      $ 1,300      $ 3,386      $ 3,801   

Expenses

    699        786        2,081        2,264   
 

 

 

   

 

 

   

 

 

   

 

 

 

Margin(2)

  $ 436      $ 514      $ 1,305      $ 1,537   

Total services business:

       

Revenues(1)

  $ 793      $ 859      $ 2,519      $ 2,653   

Services expenses

    630        694        1,976        2,097   
 

 

 

   

 

 

   

 

 

   

 

 

 

Margin(2)

  $ 163      $ 165      $ 543      $ 556   

Totals:

       

Revenues(1)

  $ 9,014      $ 9,334      $ 26,461      $ 27,541   

Expenses

    3,459        3,455        10,236        10,088   
 

 

 

   

 

 

   

 

 

   

 

 

 

Margin(2)

  $ 5,555      $ 5,879      $ 16,225      $ 17,453   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 29, 2016

(Unaudited)

 

 

(1)

Cloud software and on-premise software, software license updates and product support and hardware support revenues for management reporting included revenues related to cloud SaaS and PaaS, software support and hardware support contracts that would have otherwise been recorded by the acquired businesses as independent entities but were not recognized in our condensed consolidated statements of operations for the periods presented. See Note 7 for an explanation of these adjustments and the table below for a reconciliation of our total operating segment revenues to our total revenues as reported in our condensed consolidated statements of operations. Our cloud software and on-premise software and services revenues for management reporting also differ from amounts reported per our consolidated statements of operations for the periods presented due to certain insignificant reclassifications between these lines for management reporting purposes.

 

(2)

The margins reported reflect only the direct controllable costs of each line of business and do not include allocations of product development, marketing and partner programs, and corporate, general and administrative and information technology expenses. Additionally, the margins reported do not reflect amortization of intangible assets, acquisition related and other expenses, restructuring expenses, stock-based compensation, interest expense or certain other income (expense), net.

The following table reconciles total operating segment revenues to total revenues as well as total operating segment margin to income before provision for income taxes:

 

    Three Months Ended     Nine Months Ended  

(in millions)

  February 29,
    2016    
    February 28,
    2015    
    February 29,
    2016    
    February 28,
    2015    
 

Total revenues for operating segments

  $ 9,014      $ 9,334      $ 26,461      $ 27,541   

Cloud software as a service and platform as a service revenues(1)

    (2     (3     (6     (9

Software license updates and product support revenues(1)

           (3     (1     (9

Hardware support revenues(1)

           (1     (1     (3
 

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

  $ 9,012      $ 9,327      $ 26,453      $ 27,520   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total margin for operating segments

  $ 5,555      $ 5,879      $ 16,225      $ 17,453   

Cloud software as a service and platform as a service revenues(1)

    (2     (3     (6     (9

Software license updates and product support revenues(1)

           (3     (1     (9

Hardware support revenues(1)

           (1     (1     (3

Product development

    (1,219     (1,180     (3,652     (3,562

Marketing and partner program expenses

    (110     (116     (356     (370

Corporate, general and administrative and information technology expenses

    (403     (377     (1,197     (1,105

Amortization of intangible assets

    (408     (527     (1,283     (1,642

Acquisition related and other

    (11     (8     (35     (12

Restructuring

    (115     (48     (293     (168

Stock-based compensation

    (260     (233     (765     (684

Interest expense

    (360     (273     (1,105     (817

Non-operating income, net

    65        40        179        65   
 

 

 

   

 

 

   

 

 

   

 

 

 

Income before provision for income taxes

  $ 2,732      $ 3,150      $ 7,710      $ 9,137   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Cloud software as a service and platform as a service revenues, software license updates and product support revenues and hardware support revenues for management reporting included revenues that would have otherwise been recorded by our acquired businesses as independent entities but were not recognized in our condensed consolidated statements of operations for the periods presented due to business combination accounting requirements.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 29, 2016

(Unaudited)

 

12. 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, restricted stock-based awards 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     Nine Months Ended  

(in millions, except per share data)

  February 29,
2016
    February 28,
2015
    February 29,
2016
    February 28,
2015
 

Net income

  $   2,142      $   2,495      $   6,087      $   7,181   
 

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average common shares outstanding

    4,182        4,389        4,246        4,419   

Dilutive effect of employee stock plans

    74        105        82        97   
 

 

 

   

 

 

   

 

 

   

 

 

 

Dilutive weighted average common shares outstanding

    4,256        4,494        4,328        4,516   
 

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per share

  $ 0.51      $ 0.57      $ 1.43      $ 1.63   

Diluted earnings per share

  $ 0.50      $ 0.56      $ 1.41      $ 1.59   

Shares subject to anti-dilutive stock options and restricted stock-based awards excluded from calculation(1)

    67        39        62        36   

 

(1)

These weighted shares relate to anti-dilutive stock options and restricted stock-based awards as calculated using the treasury stock method and could be dilutive in the future.

 

13. LEGAL PROCEEDINGS

Hewlett-Packard Company Litigation

On June 15, 2011, Hewlett-Packard Company (HP) filed a complaint in the California Superior Court, County of Santa Clara against Oracle Corporation alleging numerous causes of action including breach of contract, breach of the covenant of good faith and fair dealing, defamation, intentional interference with prospective economic advantage, and violation of the California Unfair Business Practices Act. The complaint alleged that when Oracle announced on March 22 and 23, 2011 that it would no longer develop future versions of its software to run on HP’s Itanium-based servers, it breached a settlement agreement signed on September 20, 2010 between HP and Mark Hurd (the Hurd Settlement Agreement), who was both HP’s former chief executive officer and chairman of HP’s board of directors. HP sought a judicial declaration of the parties’ rights and obligations under the Hurd Settlement Agreement, and other equitable and monetary relief.

Oracle answered the complaint and filed a cross-complaint, which was amended on December 2, 2011. The amended cross-complaint alleged claims including violation of the Lanham Act. Oracle alleged that HP had secretly agreed to pay Intel to continue to develop and manufacture the Itanium microprocessor, and had misrepresented to customers that the Itanium microprocessor had a long roadmap, among other claims. Oracle sought equitable rescission of the Hurd Settlement Agreement, and other equitable and monetary relief.

The court bifurcated the trial and tried HP’s causes of action for declaratory relief and promissory estoppel without a jury in June 2012. The court issued a final statement of decision on August 28, 2012, finding that the Hurd Settlement Agreement required Oracle to continue to develop certain of its software products for use on HP’s Itanium-based servers and to port such products at no cost to HP for as long as HP sells those servers. Oracle has announced that it is appealing this decision. The issues of breach, HP’s performance, causation and damages, HP’s tort claims, and Oracle’s cross-claims will all be tried before a jury. As of April 8, 2013, the trial was stayed pending Oracle’s appeal of the court’s denial of its anti-SLAPP motion. On August 27, 2015, the Court of Appeal affirmed the trial court’s denial of Oracle’s anti-SLAPP motion. The Court of Appeal’s decision

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 29, 2016

(Unaudited)

 

became final on September 26, 2015. The matter was remanded to the trial court for further proceedings and trial, which is set to begin on May 23, 2016. We cannot currently estimate a reasonably possible range of loss for this action. We believe that we have meritorious defenses against this action, and we will continue to vigorously defend it.

State of Oregon Litigation

On August 22, 2014, the Attorney General for the State of Oregon, the State of Oregon, and the Oregon Health Insurance Exchange Corporation, doing business as Cover Oregon (Cover Oregon), filed a lawsuit in the Circuit Court of the State of Oregon for the County of Marion against Oracle, our then-President and Chief Financial Officer, three current and two former Oracle employees, and Mythics, Inc. The complaint alleges claims related to the work Oracle performed on Oregon’s healthcare exchange website and Oregon’s system for delivering health and human services to low-income residents. Thereafter, Cover Oregon was dissolved, and the Oregon Department of Consumer and Business Services (the DCBS) continued to assert Cover Oregon’s claims. Also, one of the former Oracle employees was dismissed from the lawsuit. A First Amended Complaint was filed on August 10, 2015.

The complaint alleges claims against Oracle for fraud, violations of Oregon’s False Claims Act, breach of contract, and violations of the Oregon Civil Racketeer Influenced and Corrupt Organizations Act, and alleges a violation of Oregon’s False Claims Act against each of the individuals. The complaint seeks monetary damages, statutory penalties, attorneys’ fees and costs, and a permanent injunction prohibiting Oracle from marketing to or entering into a contract with any public corporation or agency of the State of Oregon. Specifically, the complaint alleges that Oracle committed fraud by making false statements about the capabilities and functionality of its products and about the amount of time and effort it would take Oracle’s consulting and managed cloud services operations to perform the requested work. It also alleges that Oracle breached the contracts by failing to provide what was required under the contracts and failing to perform the services in a professional manner consistent with industry standards. The complaint alleges that Oracle violated Oregon’s False Claims Act by making false statements in order to obtain payment of invoices and by presenting invoices for payment that were false. The claims for violation of Oregon’s Civil Racketeer Influenced and Corrupt Organizations Act allege that Oracle violated the statute by making false statements in writing about the capabilities of Oracle’s products and the functionality and readiness of the healthcare exchange website, by using those false statements to obtain the signatures necessary to secure the contracts, execute documents, and enable payment, and by using the wires to transmit documents containing the allegedly false statements.

The claims against the individuals allege that one former employee violated Oregon’s False Claims Act by making false statements that fraudulently induced the State of Oregon to enter into its contracts with Oracle, and that the other four employees violated the statute by making false statements in order to get invoices paid.

Oracle responded to the original complaint on December 2, 2014, and filed a response to the First Amended Complaint on August 20, 2015. Oracle denied all claims and allegations and filed counterclaims against the DCBS for breach of contract, quantum meruit (a claim requesting payment for the value of services provided), and breach of the implied covenant of good faith and fair dealing. The court granted the State of Oregon’s motion to dismiss Oracle’s claims for breach of contract and the breach of the implied covenant of good faith and fair dealing. On October 26, 2015, Oracle filed its amended response to Plaintiffs’ First Amended Complaint and alleged counterclaims against the DCBS for breach of contract, breach of the implied covenant of good faith and fair dealing, breach of implied-in-fact contract, quantum meruit, and promissory estoppel (a claim seeking to enforce promises that Oracle relied upon in providing services). The State of Oregon filed a motion to dismiss all counterclaims except the causes of action for quantum meruit and promissory estoppel, and on February 5, 2016 the court granted that motion and dismissed with prejudice Oracle’s claims for breach of contract, breach of the implied covenant of good faith and fair dealing and breach of implied-in-fact contract. Oracle seeks monetary

 

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ORACLE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 29, 2016

(Unaudited)

 

damages to compensate it for the value of unpaid services and its attorneys’ fees and costs. Trial is set to begin on January 10, 2017. We cannot currently estimate a reasonably possible range of loss for this action. We believe that we have meritorious defenses against this action, and we will continue to vigorously defend it.

On August 8, 2014, Oracle filed a lawsuit in the U.S. District Court, for the District of Oregon in Portland against Cover Oregon. The complaint alleged claims for breach of contract and quantum meruit and sought monetary damages to compensate Oracle for the value of unpaid services. On September 8, 2014, Oracle filed a First Amended Complaint adding two State of Oregon agencies as defendants and adding causes of action for copyright infringement and breach of the implied covenant of good faith and fair dealing. On January 27, 2015, Oracle filed a Second Amended Complaint. Cover Oregon, now the DCBS, is a defendant as to all causes of action; the other state agencies are defendants to the cause of action for copyright infringement. In addition to monetary damages, Oracle seeks an injunction prohibiting infringement of its copyrights. All defendants moved for judgment in their favor, claiming that the state entities have sovereign immunity (that is, they cannot be sued in federal court). On November 18, 2015, the court ruled on the motions, holding that two state agencies (Oregon Health Authority and Oregon Department of Human Services) do not have sovereign immunity, but that the DCBS does have sovereign immunity. On December 9 and 17, 2015, Oracle and the Oregon parties each filed notices of appeal from that decision. The Ninth Circuit Court of Appeals has coordinated the two matters, and briefing will begin in late April 2016.

On November 12, 2015, Oracle filed a lawsuit in the Circuit Court of the State of Oregon for the County of Marion against Oregon’s Governor, Kate Brown, in her official capacity. Oracle filed a First Amended Complaint on January 15, 2016. In this lawsuit, Oracle alleges violations of Oregon’s Public Records Law and seeks a court order declaring that Governor Brown has violated Oregon’s Public Records Law and compelling compliance with that law. The Governor has moved to dismiss the complaint.

On January 21, 2016, Oracle filed a lawsuit in the Circuit Court of the State of Oregon for the County of Marion against the State of Oregon, by and through Governor Kate Brown, Attorney General Ellen Rosenblum, and three state agencies. In this lawsuit, Oracle seeks to enforce an October 2015 oral agreement to resolve all pending litigation between Oracle and the State of Oregon. The State of Oregon has moved to dismiss the complaint.

On March 8, 2016, Oracle filed a Complaint for a Writ of Mandamus in the U.S. District Court for the District of Columbia against Sylvia Burwell, Secretary, U.S. Department of Health and Human Services, in her official capacity. In this lawsuit, Oracle alleges that, as to the State of Oregon and the Oregon Health Insurance Exchange, the Secretary failed to exercise her mandatory oversight duties under the Affordable Care Act to monitor the integrity and performance of states and state health insurance exchanges that receive federal funds. Oracle seeks an order requiring the Secretary to exercise that mandatory duty and (1) direct the State of Oregon to stay or dismiss its lawsuit against Oracle, and (2) monitor and investigate all work Oregon and its subgrantees and contractors, including Oracle, did on the health insurance exchange project to determine what liabilities involving federal funds, if any, have arisen from it.

Other Litigation

We are party to various other 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 matters, individually or in the aggregate, will result in losses that are materially in excess of amounts already recognized, if any.

 

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Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

We begin Management’s Discussion and Analysis of Financial Condition and Results of Operations with an overview of our businesses, key operating segments and significant trends. This overview is followed by a summary 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 results of operations and financial condition.

Business Overview

Oracle Corporation provides products and services that address all aspects of corporate information technology (IT) environments—application, platform and infrastructure—and are available to customers either via cloud computing or on-premise deployment models. Our offerings include database and middleware software, application software, cloud infrastructure software, hardware (Oracle Engineered Systems, servers, storage, networking and industry specific products), and related support and services. We offer to over 400,000 worldwide customers a choice of deployment models to best suit their needs including (1) the deployment of our products via our Oracle Cloud offerings, (2) the acquisition of Oracle products and services for an on-premise IT environment or (3) a mix of these two models.

For customers opting for a cloud computing model, Oracle offers a comprehensive and fully integrated stack of cloud applications and platform services in all three primary layers of the cloud: Software as a Service (SaaS), Platform as a Service (PaaS) and Infrastructure as a Service (IaaS). Our Integrated Cloud offerings are designed to be rapidly deployable to enable customers shorter time to innovation; easily maintainable to reduce integration and testing work; connectable among differing deployment models to enable interchangeability and extendibility between cloud and on-premise IT environments; and cost effective by requiring lower upfront customer investment. Our Oracle Cloud offerings integrate the software, hardware and services on the customer’s behalf in IT environments that we deploy, support and manage for the customer. We are a leader in the core technologies of cloud IT environments, including database and middleware software as well as enterprise applications, virtualization, clustering, large-scale systems management and related infrastructure. Our products and services are the building blocks of our Oracle Cloud services, our partners’ cloud services and our customers’ cloud IT environments. In addition to offering a broad spectrum of cloud products and services, we have for decades developed and sold our products and services to our customers worldwide for use in their global data centers and on-premise IT environments.

An important element of our corporate strategy is to continue our investments in, and innovation with respect to, our products and services that we offer through our cloud and on-premise software, hardware and services businesses. We have a deep understanding as to how all components within IT environments—application, platform and infrastructure—interact and function with one another. We focus our development efforts on improving the performance, operation and integration of these differing technologies to make them more cost-effective and easier to deploy, manage and maintain for our customers and to improve their computing performance relative to our competitors. After the initial purchase of Oracle products and services, our customers can continue to take advantage of our research and development investments and deep IT expertise by purchasing and renewing Oracle support offerings, which may include product enhancements that we periodically deliver to our Oracle E-Business Suite, Siebel, PeopleSoft and JD Edwards application software products, among others, or by renewing their SaaS, PaaS and IaaS contracts with us.

Oracle customers are increasingly electing to run their IT environments using our Integrated Cloud offerings. As customers deploy with the Oracle Cloud, many are adopting a hybrid IT model whereby certain of their IT resources are deployed and managed through the Oracle Cloud, while other of their IT resources are deployed and managed on-premise, and both sets of resources can be managed as one. We focus the engineering of our products and services to best connect these different deployment models to enable flexibility, ease, agility, compatibility, extensibility and seamlessness.

A selective and active acquisition program is another important element of our corporate strategy. We believe our acquisitions enhance the products and services that we can offer to customers, expand our customer base, provide greater scale to accelerate innovation, grow our revenues and earnings, and increase stockholder value.

 

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In recent years, we have invested billions of dollars to acquire a number of companies, products, services and technologies that add to, are complementary to, or have otherwise enhanced our existing offerings. We expect to continue to acquire companies, products, services and technologies to further our corporate strategy.

We have three businesses that deliver our application, platform and infrastructure technologies: cloud and on-premise software, hardware, and services. These businesses can be further divided into certain operating segments (Note 11 of Notes to Condensed Consolidated Financial Statements, included elsewhere in this Quarterly Report, provides additional information related to our operating segments). Each of our businesses and operating segments has unique characteristics and faces different opportunities and challenges. An overview of our three businesses and related operating segments follows.

Cloud and On-Premise Software Business

Our cloud and on-premise software business, which represented 78% of our total revenues on a trailing 4-quarter basis, is comprised of three operating segments: (1) cloud software and on-premise software, (2) cloud infrastructure as a service and (3) software license updates and product support. On a constant currency basis, we expect that our cloud and on-premise software business’ total revenues generally will continue to increase due to continued demand for our software products and cloud software subscription offerings, our software license updates and product support offerings, including the high percentage of customers that renew their software license updates and product support contracts, and our acquisitions, which should allow us to grow and continue to make investments in research and development.

Cloud Software and On-Premise Software:    Our cloud software and on-premise software line of business markets, sells and delivers our application and platform technologies through our SaaS and PaaS offerings, which are certain of our software applications and platforms that are delivered via a cloud-based IT environment that we host, manage and support, and through the licensing of our software products including Oracle Applications, Oracle Database, Oracle Fusion Middleware and Java, among others. Our application and platform technologies are substantially built on standards-based architectures that are designed to help customers reduce the cost and complexity of their IT infrastructure. Our commitment to industry standards results in software that works in customer environments with Oracle or non-Oracle hardware or software components and that can be adapted to meet specific industry or business needs. We focus the engineering of our products and services to best connect cloud and on-premise deployment models to enable flexibility, ease, agility, compatibility, extensibility and seamlessness. Our software offerings are substantially designed to operate on both single server and clustered server configurations for cloud or on-premise IT environments, and to support a choice of operating systems including Oracle Solaris, Oracle Linux, Microsoft Windows and third party UNIX products, among others. These approaches are designed to support customer choice and reduce customer risk. Our customers include businesses of many sizes, government agencies, educational institutions and resellers. We market and sell our software offerings to these customers with a sales force positioned to offer the combinations that best fit their needs. We enable customers to evolve and transform to substantially any IT environment at whatever pace is most appropriate for them.

Cloud software and on-premise software revenues represented 26% of our total revenues on a trailing 4-quarter basis. The growth in our SaaS and PaaS revenues and new software licenses revenues that we report is affected by the strength of general economic and business conditions, governmental budgetary constraints, the strategy for and competitive position of our software offerings, our acquisitions, our ability to deliver and renew our SaaS and PaaS contracts with our existing customers and foreign currency fluctuations. In recent periods, we have placed significant strategic emphasis on growing our cloud SaaS and PaaS revenues, which has affected the growth of our cloud SaaS and PaaS revenues and our new software licenses revenues. We expect this trend will continue for at least the near term.

The substantial majority of our new software license transactions are characterized by long sales cycles and the timing of a few large software license transactions can substantially affect our quarterly new software licenses revenues. Our SaaS and PaaS arrangements are generally one to three years in duration and we strive to renew these contracts when they are eligible for renewal. Our cloud software and on-premise software segment’s margin has historically trended upward over the course of the four quarters within a particular fiscal year due to the historical upward trend of our new software licenses revenues over those quarterly periods and because the

 

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majority of our costs for this segment are predominantly fixed in the short term. However, as discussed further below under “Supplemental Disclosure Related to Certain Charges”, our cloud software and on-premise software segment’s margin has been and will continue to be affected by the fair value adjustments relating to the cloud SaaS and PaaS obligations that we assumed in our business combinations and by the amortization of intangible assets associated with companies and technologies that we have acquired.

Cloud Infrastructure as a Service:    Our cloud infrastructure as a service offerings, which represented 2% of our total revenues on a trailing 4-quarter basis, provide comprehensive software and hardware management and maintenance services for customer IT infrastructure for a fee for a stated term that is hosted at our Oracle data center facilities, select partner data centers or physically on-premise at customer facilities; and deployment and management offerings for our software and hardware and related IT infrastructure including virtual machine instances that are subscription-based and designed for computing and reliable and secure object storage.

Software License Updates and Product Support:    Software license updates and product support revenues are generated through the sale of software support contracts relating to on-premise new software licenses purchased by our customers. Customers that purchase software license updates and product support are granted rights to unspecified product upgrades and maintenance releases and patches released during the term of the support period, as well as technical support assistance. Our software license updates and product support contracts are generally one year in duration. Substantially all of our software license customers renew their software license updates and product support contracts annually. The growth of software license updates and product support revenues is primarily influenced by three factors: (1) the percentage of our software support contract customer base that renews its software support contracts, (2) the amount of new software support contracts sold in connection with the sale of new software licenses and (3) the amount of software support contracts assumed from companies we have acquired.

Software license updates and product support revenues, which represented 50% of our total revenues on a trailing 4-quarter basis, is our highest margin business unit. Our software support margins over the trailing 4-quarters were 90% and accounted for 85% of our total margins over the same period. Our software license updates and product support margins have been affected by fair value adjustments relating to software support obligations assumed in business combinations and by the amortization of intangible assets, both of which are discussed further below under “Supplemental Disclosure Related to Certain Charges”. However, over the longer term, we believe that software license updates and product support revenues and margins will grow for the following reasons:

 

   

substantially all of our customers, including customers from acquired companies, renew their software support contracts when eligible for renewal;

 

   

substantially all of our customers purchase software license updates and product support contracts when they buy new software licenses, resulting in a further increase in our software support contract base. Even if new software licenses revenues growth was flat, software license updates and product support revenues would continue to grow in comparison to the corresponding prior year periods assuming contract renewal and cancellation rates and foreign currency rates remained relatively constant, since substantially all new software licenses transactions result in the sale of software license updates and product support contracts, which add to our software support contract base; and

 

   

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

Hardware Business

Our hardware business is comprised of two operating segments: (1) hardware products and (2) hardware support. Our hardware business represented 13% of our total revenues on a trailing 4-quarter basis. We expect our hardware business to have lower operating margins as a percentage of revenues than our cloud and on-premise software business due to the incremental costs we incur to produce and distribute these products and to provide support services, including direct materials and labor costs. We expect to make investments in research and development to improve existing hardware products and services and to develop new hardware products and services.

 

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Hardware Products:    We provide a broad selection of hardware and related services, including Oracle Engineered Systems, servers, storage, networking, workstations and related devices, industry specific hardware, virtualization software, operating systems, and management software to support diverse IT environments, including cloud computing environments. We engineer our hardware products with virtualization and management capabilities to enable the rapid deployment and efficient management of cloud and on-premise IT infrastructures. Our hardware products support many of the world’s largest cloud infrastructures, including the Oracle Cloud.

Our hardware products are designed to be easier to deploy, manage and maintain for our customers and to improve computing performance relative to our competitors’ offerings. We design our hardware products to seamlessly connect on-premise and cloud IT environments to further enable interoperability, interchangeability and extendibility and to work in customer environments that may include other Oracle or non-Oracle hardware or software components. Our flexible and open approach provides Oracle customers with a broad range of choices in how they deploy our hardware products, which we believe is a priority for our customers.

Oracle Engineered Systems are core to our hardware offerings and are important elements of our data center and cloud computing offerings including the Oracle Cloud. These pre-integrated products are designed to integrate multiple Oracle technology components to work together to deliver improved performance, availability, security and operational efficiency relative to our competitors’ products; to be upgraded effectively and efficiently; and to simplify maintenance cycles by providing a single solution for software patching. Oracle Engineered Systems are tested before they are shipped to customers and delivered ready-to-run, enabling customers to shorten deployment time to production.

We offer a wide range of server products using our SPARC microprocessor. Our SPARC servers run the Oracle Solaris operating system and are designed to be differentiated by their reliability, security, and scalability. Our mid-size and large servers are designed to offer better performance and lower total cost of ownership than mainframe products for business critical applications, for customers having more computationally intensive needs, and as platforms for building cloud computing IT environments. Our SPARC servers are also a core component of the Oracle SuperCluster, one of our Oracle Engineered Systems.

We also offer enterprise x86 servers. These x86 servers are based on microprocessors from Intel Corporation and are compatible with Oracle Solaris, Oracle Linux, Microsoft Windows and other operating systems. Our x86 servers are also a core component of many of our Oracle Engineered Systems including Oracle Exadata Database Machine, Oracle Exalogic Elastic Cloud, Oracle Exalytics In-Memory Machine and the Oracle Big Data Appliance.

Our storage products are designed to securely manage, protect, archive and restore customers’ mission critical data assets and consist of tape, disk, flash and hardware-related software including file systems software, back-up and archive software and storage management software and networking for mainframe and open systems environments.

Our networking and data center fabric products, including Oracle Virtual Networking, and Oracle InfiniBand and Ethernet technologies, are used with our server and storage products and are integrated into our management tools to help enterprise customers improve infrastructure performance, reduce cost and complexity and simplify storage and server connectivity.

We offer hardware products and services designed for specific industries. Our point-of-sale hardware offerings include point-of-sale terminals and related hardware that are designed for managing businesses within the food and beverage, hotel and retail industries, among others. Our hardware products and services for communications networks include network signaling, policy control and subscriber data management solutions, and session border control technology, among others.

The majority of our hardware products are sold through indirect channels, including independent distributors and value added resellers.

To produce our hardware products, we rely on both our internal manufacturing operations as well as third-party manufacturing partners. Our internal manufacturing operations consist primarily of materials procurement, assembly, testing and quality control of our Oracle Engineered Systems and certain of our enterprise and data

 

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center servers and storage products. For all other manufacturing, we generally rely on third-party manufacturing partners to produce our hardware-related components and hardware products and we may involve our internal manufacturing operations in the final assembly, testing and quality control processes for these components and products. We distribute most of our hardware products either from our facilities or partner facilities. We strive to reduce costs by simplifying our manufacturing processes through increased standardization of components across product types and a “build-to-order” manufacturing process in which products generally are built only after customers have placed firm orders.

Our hardware products revenues, cost of hardware products and hardware operating margins that we report are affected by our strategy for and the competitive position of our hardware products, the strength of general economic and business conditions, governmental budgetary constraints, certain of our acquisitions and foreign currency rate fluctuations. In addition, our operating margins for our hardware products segment have been and will be affected by the amortization of intangible assets.

Our quarterly hardware products revenues are difficult to predict. The timing of customer orders and delays in our ability to timely manufacture or deliver a few large hardware transactions, among other factors, could substantially affect the amount of hardware products revenues, expenses and operating margins that we report.

Hardware Support:    Our hardware support offerings provide customers with software updates for software components that are essential to the functionality of our hardware products, such as Oracle Solaris and certain other software products, and can include product repairs, maintenance services and technical support services. Typically, our hardware support contract arrangements are priced as a percentage of the net hardware products fees, are invoiced to the customer at the beginning of the support period and are one year in duration. We continue to evolve hardware support processes that are intended to proactively identify and solve quality issues and to increase the amount of new and renewed hardware support contracts sold in connection with the sales of our hardware products. Our hardware support revenues that we report are influenced by a number of factors, including the volume of purchases of hardware products, the mix of hardware products purchased, whether customers decide to purchase hardware support contracts at or in close proximity to the time of hardware product sale, the percentage of our hardware support contract customer base that renews its support contracts and our acquisitions. Substantially all of these factors are heavily influenced by our customers’ decisions to either maintain or upgrade their existing hardware infrastructure to newly developed technologies that are available.

Our hardware support margins have been and will be affected by certain of our acquisitions and related accounting, including fair value adjustments relating to hardware support obligations assumed and by the amortization of intangible assets, both of which are discussed further below under “Supplemental Disclosure Related to Certain Charges”.

Services Business

Our services business, which represented 9% of our total revenues on a trailing 4-quarter basis, is comprised of the remainder of our operating segments. Our services business has lower margins than our cloud and on-premise software and hardware businesses. Our services revenues are impacted by our strategy for and the competitive position of our services, certain of our acquisitions, general economic conditions, governmental budgetary constraints, personnel reductions in our customers’ IT departments, tighter controls over discretionary spending and the growth in our software and hardware products revenues. Our services business’ offerings include:

 

   

consulting services that are designed to help our customers and global system integrator partners more successfully architect and deploy our offerings, including IT strategy alignment, enterprise architecture planning and design, initial software implementation and integration, and ongoing software enhancements and upgrades. We utilize a global, blended delivery model to optimize value for our customers and partners, consisting of on-premise consultants from local geographies, industry specialists and consultants from our global delivery and solution centers;

 

   

advanced customer support services, which are provided on-premise and remotely to our customers to enable increased performance and higher availability of their Oracle products and services and also include certain other services; and

 

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education services for Oracle products and services, including training and certification programs that are offered to customers, partners and employees through a variety of formats, including instructor-led classes at our education centers, live virtual training, self-paced online training, private events and custom training.

Acquisitions

A selective and active acquisition program is another important element of our corporate strategy. In recent years, we have invested billions of dollars to acquire a number of complementary companies, products, services and technologies, including MICROS Systems, Inc. (MICROS) in the second quarter of fiscal 2015, among others. We believe our acquisition program strengthens our competitive position, enhances the products and services that we can offer to customers, expands our customer base, provides greater scale to accelerate innovation, grows our revenues and earnings and increases stockholder value. We expect to continue to acquire companies, products, services and technologies in furtherance of our corporate strategy. Note 2 of Notes to Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report provides additional information related to our recent acquisitions.

We believe we can fund our future acquisitions with our internally available cash, cash equivalents and marketable securities, cash generated from operations, additional borrowings or from the issuance of additional securities. We estimate the financial impact of any potential acquisition with regard to earnings, operating margin, cash flow and return on invested capital targets before deciding to move forward with an acquisition.

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP) as set forth in the Financial Accounting Standards Board’s Accounting Standards Codification (ASC), and we consider the various staff accounting bulletins and other applicable guidance issued by the U.S. Securities and Exchange Commission. GAAP, as set forth within the ASC, requires 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 that there are differences between these estimates, judgments or assumptions and actual results, our financial statements will be affected. The accounting policies that reflect our more significant estimates, judgments and assumptions and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:

 

   

Revenue Recognition;

 

   

Business Combinations;

 

   

Goodwill and Intangible Assets—Impairment Assessments;

 

   

Accounting for Income Taxes;

 

   

Legal and Other Contingencies; and

 

   

Stock-Based Compensation.

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 our critical accounting policies and related disclosures with the Finance and Audit Committee of the Board of Directors.

During the first nine months of fiscal 2016, there were no significant changes to our critical accounting policies and estimates. Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for our fiscal year ended May 31, 2015 provides a more complete discussion of our critical accounting policies and estimates.

 

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Results of Operations

Impact of Acquisitions

The comparability of our operating results in the third quarter and first nine months of fiscal 2016 compared to the same periods of fiscal 2015 was impacted by our recent acquisitions.

In our discussion of changes in our results of operations from the third quarter and first nine months of fiscal 2016 compared to the same periods of fiscal 2015, we may qualitatively disclose the impact of our acquired products and services (for the one-year period subsequent to the acquisition date) to the growth in certain of our operating segments’ revenues where such qualitative discussions would be meaningful for an understanding of the factors that influenced the changes in our results of operations. When material, we may also provide quantitative disclosures related to such acquired products and services. The contributions of our acquisitions to certain of our operating segments’ revenues, margins and expenses for each of the respective period comparisons, however, generally are not provided in our discussions, as they either were not separately identifiable due to the integration of these businesses and operating segments into our existing operations, and/or were insignificant to our results of operations during the periods presented.

We caution readers that, while pre- and post-acquisition comparisons, as well as any quantified amounts themselves, may provide indications of general trends, any acquisition information that we provide has inherent limitations for the following reasons:

 

   

any qualitative and quantitative disclosures cannot specifically address or quantify the substantial effects attributable to changes in business strategies, including our sales force integration efforts. We believe that if our acquired companies had operated independently and sales forces had not been integrated, the relative mix of products sold would have been different; and

 

   

although substantially all of our software license customers, including customers from acquired companies, renew their software license updates and product support contracts when the contracts are eligible for renewal, and we strive to renew cloud SaaS and PaaS contracts and hardware support contracts, the amounts shown as cloud SaaS and PaaS deferred revenues, software license updates and product support deferred revenues, and hardware support deferred revenues in our “Supplemental Disclosure Related to Certain Charges” (presented below) are not necessarily indicative of revenue improvements we will achieve upon contract renewals to the extent customers do not renew.

Seasonality

Our quarterly revenues have historically been affected by a variety of seasonal factors, including the structure of our sales force incentive compensation plans, which are common in the technology industry. In each fiscal year, our total revenues and operating margins are typically highest in our fourth fiscal quarter and lowest in our first fiscal quarter. The operating margins of our businesses are generally affected by seasonal factors in a similar manner as our revenues (in particular, our cloud software and on-premise software segment) as certain expenses within our cost structure are relatively fixed in the short term.

Constant Currency Presentation

Our international operations have provided and are expected to continue to provide a significant portion of our total revenues and expenses. As a result, total revenues and expenses will continue to be affected by changes in the U.S. Dollar against major international currencies. In order to provide a framework for assessing how our underlying businesses performed excluding the effects of foreign currency fluctuations, we compare the percent change in the results from one period to another period in this Quarterly Report using constant currency disclosure. To present this information, current and comparative prior period results for entities reporting in currencies other than U.S. Dollars are converted into U.S. Dollars at constant exchange rates (i.e., the rates in effect on May 31, 2015, 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 29, 2016 and February 28, 2015, our financial statements would reflect reported revenues of $1.10 million in the first nine months of fiscal 2016 (using 1.10 as the month-end average

 

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exchange rate for the period) and $1.13 million in the first nine months of fiscal 2015 (using 1.13 as the month-end average exchange rate for the period). The constant currency presentation, however, would translate the results for the three and nine months ended February 29, 2016 and February 28, 2015 using the May 31, 2015 exchange rate and indicate, in this example, no change in revenues during the period. In each of the tables below, we present the percent change based on actual, unrounded results in reported currency and in constant currency.

Total Revenues and Operating Expenses

 

    Three Months Ended     Nine Months Ended  
    February  29,
2016
    Percent Change     February  28,
2015
    February  29,
2016
    Percent Change     February  28,
2015
 

(Dollars in millions)

    Actual     Constant         Actual     Constant    

Total Revenues by Geography:

               

Americas

  $     4,942        -4%        -1%      $     5,134      $     14,620        -2%        1%      $     14,974   

EMEA(1)

    2,661        -5%        1%        2,813        7,761        -7%        3%        8,313   

Asia Pacific(2)

    1,409        2%        8%        1,380        4,072        -4%        6%        4,233   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total revenues

    9,012        -3%        1%        9,327        26,453        -4%        2%        27,520   

Total Operating Expenses

    5,985        1%        4%        5,944        17,817        1%        6%        17,631   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total Operating Margin

  $ 3,027        -11%        -5%      $ 3,383      $ 8,636        -13%        -4%      $ 9,889   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total Operating Margin %

    34%            36%        33%            36%   

% Revenues by Geography:

               

Americas

    55%            55%        55%            55%   

EMEA

    29%            30%        29%            30%   

Asia Pacific

    16%            15%        16%            15%   

Total Revenues by Business:

               

Cloud and on-premise software

  $ 7,084        -1%        3%      $ 7,170      $ 20,551        -2%        4%      $ 21,075   

Hardware

    1,135        -13%        -8%        1,299        3,385        -11%        -4%        3,798   

Services

    793        -7%        -2%        858        2,517        -5%        2%        2,647   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total revenues

  $ 9,012        -3%        1%      $ 9,327      $ 26,453        -4%        2%      $ 27,520   
 

 

 

       

 

 

   

 

 

       

 

 

 

% Revenues by Business:

               

Cloud and on-premise software

    78%            77%        78%            76%   

Hardware

    13%            14%        13%            14%   

Services

    9%            9%        9%            10%   

 

(1) 

Comprised of Europe, the Middle East and Africa

(2) 

Asia Pacific includes Japan

Our results of operations for the third quarter and first nine months of fiscal 2016 compared to our results of operations for the corresponding prior year periods were significantly impacted by movements in international currencies relative to the U.S. Dollar, which decreased our total revenues by 4 and 6 percentage points, total operating expenses by 3 and 5 percentage points and total operating margin by 6 and 9 percentage points during the third quarter and first nine months of fiscal 2016, respectively.

Excluding the effects of unfavorable currency variations, our total revenues increased in the fiscal 2016 periods presented due to constant currency growth in our cloud and on-premise software revenues, which was attributable to growth in our software license updates and product support revenues, growth in our SaaS, PaaS and IaaS revenues, and revenue contributions from our recent acquisitions. These constant currency increases in our revenues for the fiscal 2016 periods presented were primarily offset by constant currency decreases in our hardware business revenues during the fiscal 2016 periods presented. On a constant currency basis, total revenues growth was primarily attributable to the EMEA and Asia Pacific regions during the third quarter of fiscal 2016, partially offset by a modest decrease in the Americas region. In constant currency, the Americas region contributed 24%, the EMEA region contributed 41% and the Asia Pacific region contributed 35% of our total revenues growth during the first nine months of fiscal 2016.

 

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Excluding the effects of favorable currency variations, our total operating expenses increased during the fiscal 2016 periods presented primarily due to increased sales and marketing and research and development expenses resulting primarily from increased headcount, increased cloud SaaS and PaaS expenses resulting from increased headcount and infrastructure expenses to support the increase in our cloud SaaS and PaaS revenues, and higher restructuring expenses that were recorded pursuant to the Fiscal 2015 Oracle Restructuring Plan (2015 Restructuring Plan; see Note 6 of Notes to Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report). These constant currency expense increases were partially offset by reductions in expenses associated with certain of our intangible assets that became fully amortized during the fiscal 2016 periods presented.

Excluding the effects of unfavorable foreign currency rate fluctuations, our total operating margin and total operating margin as a percentage of revenues decreased during the fiscal 2016 periods presented as our total expenses increased at a faster rate than our total revenues.

Supplemental Disclosure Related to Certain Charges

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. You should review the introduction under “Impact of Acquisitions” (above) for a discussion of the inherent limitations in comparing pre- and post-acquisition information.

Our operating results included the following business combination accounting adjustments and expenses related to acquisitions, as well as certain other expense and income items:

 

    Three Months Ended     Nine Months Ended  

(in millions)

  February 29,
     2016    
    February 28,
     2015    
    February 29,
     2016    
    February 28,
     2015    
 

Cloud software as a service and platform as a service deferred revenues(1)

  $ 2      $ 3      $ 6      $ 9   

Software license updates and product support deferred revenues(1)

           3        1        9   

Hardware support deferred revenues(1)

           1        1        3   

Amortization of intangible assets(2)

    408        527        1,283        1,642   

Acquisition related and other(3)(5)

    11        8        35        12   

Restructuring(4)

    115        48        293        168   

Stock-based compensation(5)

    260        233        765        684   

Income tax effects(6)

    (207     (247     (658     (715
 

 

 

   

 

 

   

 

 

   

 

 

 
  $ 589      $ 576      $ 1,726      $ 1,812   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

In connection with our acquisitions, we have estimated the fair values of the cloud SaaS and PaaS subscriptions, software support and hardware support obligations assumed. Due to our application of business combination accounting rules, we did not recognize the cloud SaaS and PaaS, software license updates and product support and hardware support revenue amounts as presented in the above table that would have otherwise been recorded by the acquired businesses as independent entities upon delivery of the contractual obligations. To the extent customers to which these contractual obligations pertain renew these contracts with us, we expect to recognize revenues for the full contracts’ values over the respective contracts’ renewal periods.

 

(2) 

Represents the amortization of intangible assets, substantially all of which were acquired in connection with our acquisitions. As of February 29, 2016, estimated future amortization expenses related to intangible assets were as follows (in millions):

 

Remainder of fiscal 2016

   $ 353   

Fiscal 2017

     1,016   

Fiscal 2018

     867   

Fiscal 2019

     760   

Fiscal 2020

     615   

Fiscal 2021

     470   

Thereafter

     1,168   
  

 

 

 

Total intangible assets, net

   $     5,249   
  

 

 

 

 

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(3) 

Acquisition related and other expenses primarily consist of personnel related costs for transitional and certain other employees, stock-based compensation expenses, integration related professional services, certain business combination adjustments including certain adjustments after the measurement period has ended and certain other operating items, net.

 

(4) 

Restructuring expenses during the first nine months of fiscal 2016 primarily related to employee severance in connection with our 2015 Restructuring Plan. Restructuring expenses during the first nine months of fiscal 2015 primarily related to costs incurred pursuant to our 2015 Restructuring Plan and our Fiscal 2013 Oracle Restructuring Plan (2013 Restructuring Plan). Additional information regarding certain of our restructuring plans is provided in Note 6 of Notes to Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report and in Note 9 of Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended May 31, 2015.

 

(5) 

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

 

     Three Months Ended      Nine Months Ended  
     February 29,
2016
     February 28,
2015
     February 29,
2016
     February 28,
2015
 

Sales and marketing

   $ 57       $ 45       $ 163       $ 131   

Cloud software as a service and platform as a service

     4         3         13         8   

Cloud infrastructure as a service

     1         1         3         3   

Software license updates and product support

     6         6         18         15   

Hardware products

     1         1         4         4   

Hardware support

     1         2         4         4   

Services

     7         8         22         23   

Research and development

     154         138         452         380   

General and administrative

     29         29         86         116   
  

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     260         233         765         684   

Acquisition related and other

             1         3         5   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total stock-based compensation

   $ 260       $ 234       $ 768       $ 689   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Stock-based compensation included in acquisition related and other expenses resulted from unvested stock options and restricted stock-based awards assumed from acquisitions whose vesting was accelerated upon termination of the employees pursuant to the terms of those stock options and restricted stock-based awards.

 

(6) 

The income tax effects presented were calculated as if the above described charges were not included in our results of operations for each of the respective periods presented. Income tax effects for the third quarter and first nine months of fiscal 2016 were calculated based on the applicable jurisdictional tax rates applied to the items within the table above and resulted in effective tax rates of 22.6% for both fiscal 2016 periods presented, instead of 21.6% and 21.0%, respectively, which represented our effective tax rates as derived per our condensed consolidated statements of operations, primarily due to the net tax effects of acquisition related items, including the tax effects of amortization of intangible assets for the third quarter and first nine months of fiscal 2016. Income tax effects for the third quarter and first nine months of fiscal 2015 were calculated reflecting effective tax rates of 22.7% and 22.9%, respectively, instead of 20.8% and 21.4%, respectively, which represented our effective tax rates as derived per our condensed consolidated statements of operations, primarily due to the same reasons as noted for the fiscal 2016 periods presented.

Cloud and On-Premise Software Business

Our cloud and on-premise software business consists of our cloud software and on-premise software segment, our cloud infrastructure as a service segment and our software license updates and product support segment.

Cloud Software and On-Premise Software:    Our cloud software and on-premise software segment engages in the sale, marketing and delivery of our cloud software offerings, including our cloud SaaS and PaaS offerings, and the licensing of our software for on-premise IT environments. Our cloud SaaS and PaaS offerings grant customers access to a broad range of our application and platform software technologies on a subscription basis in a secure, standards-based, cloud computing environment that generally includes access, hosting, infrastructure management, the use of software updates, and support. New software licenses revenues represent fees earned from granting customers licenses to use our database and middleware and our application software products within on-premise IT environments. 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. Costs associated with our cloud software and on-premise software segment are included in sales and marketing expenses, cloud SaaS and PaaS expenses and amortization of intangible assets. These costs

 

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are largely personnel related and include commissions earned by our sales force for the sale of our software offerings, marketing program costs, the cost of providing our cloud SaaS and PaaS offerings and amortization of intangible assets.

 

    Three Months Ended     Nine Months Ended  
    February  29,
2016
    Percent Change     February  28,
2015
    February 29,
2016
    Percent Change     February 28,
2015
 

(Dollars in millions)

    Actual     Constant         Actual     Constant    

Cloud Software and On-Premise Software Revenues:

               

Americas

  $ 1,189        -8%        -5%      $ 1,293      $ 3,262        -9%        -6%      $ 3,582   

EMEA

    645        -8%        -2%        701        1,651        -8%        0%        1,797   

Asia Pacific

    429        19%        24%        360        1,113        2%        11%        1,087   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total revenues

    2,263        -4%        0%        2,354        6,026        -7%        -1%        6,466   

Expenses:

               

Cloud software as a service and platform as a service(1)

    288        43%        47%        200        834        64%        70%        509   

Sales and marketing(1)

    1,620        5%        10%        1,546        4,712        3%        10%        4,582   

Stock-based compensation

    57        28%        28%        44        165        27%        27%        130   

Amortization of intangible assets(2)

    204        -20%        -20%        255        634        -17%        -17%        760   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total expenses

    2,169        6%        10%        2,045        6,345        6%        12%        5,981   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total Margin

  $ 94        -69%        -66%      $ 309      $ (319     -166%        -166%      $ 485   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total Margin %

    4%            13%        -5%            8%   

% Revenues by Geography:

               

Americas

    53%            55%        54%            55%   

EMEA

    28%            30%        27%            28%   

Asia Pacific

    19%            15%        19%            17%   

Revenues by Software Offerings:

               

Cloud software as a service and platform as a service

  $ 583        57%        61%      $ 372      $ 1,517        42%        46%      $ 1,069   

New software licenses

    1,680        -15%        -11%        1,982        4,509        -16%        -11%        5,397   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total cloud software and on-premise software revenues

  $ 2,263        -4%        0%      $ 2,354      $ 6,026        -7%        -1%      $ 6,466   
 

 

 

       

 

 

   

 

 

       

 

 

 

% Revenues by Software Offerings:

               

Cloud software as a service and platform as a service

    26%            16%        25%            17%   

New software licenses

    74%            84%        75%            83%   

 

(1) 

Excluding stock-based compensation

 

(2) 

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

Excluding the effects of unfavorable currency rate fluctuations of 4 and 6 percentage points in the third quarter and first nine months of fiscal 2016, respectively, total revenues from our cloud software and on-premise software segment were flat and decreased by 1 percentage point, respectively, relative to the corresponding prior year periods. During each of the fiscal 2016 periods presented, our cloud software and on-premise software segment revenues grew due to our cloud SaaS and PaaS revenues and revenue contributions from our recent acquisitions, and were offset by decreases in our new software licenses revenues. The increases in our cloud SaaS and PaaS revenues and decreases in our new software licenses revenues during the fiscal 2016 periods presented were primarily due to the strategic emphasis placed on selling, marketing and growing our cloud software offerings and we expect these revenue trends will continue. For the fiscal 2016 periods presented, total cloud software and on-premise software constant currency revenues grew in the Asia Pacific region and were primarily offset by revenue decreases in the Americas region.

In reported currency, new software licenses revenues earned from transactions of $3 million or greater decreased by 25% and 28% in the third quarter and first nine months of fiscal 2016, respectively, and represented 25% and 24% of our new software licenses revenues in the third quarter and first nine months of fiscal 2016, respectively, in comparison to 28% in each of the third quarter and first nine months of fiscal 2015.

Excluding the effects of favorable currency rate fluctuations of 4 and 6 percentage points in the first quarter and first nine months of fiscal 2016, respectively, total cloud software and on-premise software expenses increased in the fiscal 2016 periods presented relative to the corresponding prior year periods primarily due to higher employee related expenses from increased headcount and higher cloud SaaS and PaaS expenses incurred to support the related revenues

 

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increases. These increases were partially offset by a reduction in expenses associated with certain of our intangible assets that became fully amortized.

Excluding the effects of unfavorable currency rate fluctuations, our cloud software and on-premise software segment’s total margin and total margin as a percentage of revenues decreased in the fiscal 2016 periods presented due primarily to growth in our total expenses for this operating segment.

Cloud Infrastructure as a Service:    Our cloud infrastructure as a service segment provides comprehensive software and hardware management and maintenance services for customer IT infrastructure for a fee for a stated term that is hosted at our Oracle data center facilities, select partner data centers or physically on-premise at customer facilities; and virtual machine instance services that are subscription-based in which we deploy, secure, provision, manage and maintain certain of our hardware products for our customers to provide them with a set of cloud-based core infrastructure capabilities like elastic compute and storage services to run workloads in the cloud. Cloud IaaS expenses consist primarily of personnel related expenditures, technology infrastructure expenditures and facilities costs. For all periods presented, our cloud IaaS segment’s revenues and expenses were substantially attributable to our comprehensive software and hardware management, maintenance and hosting services.

 

    Three Months Ended     Nine Months Ended  
    February 29,
2016
    Percent Change     February 28,
2015
    February 29,
2016
    Percent Change     February 28,
2015
 

(Dollars in millions)

    Actual     Constant         Actual     Constant    

Cloud Infrastructure as a Service Revenues:

               

Americas

  $ 113        -2%        1%      $ 115      $ 349        7%        11%      $ 326   

EMEA

    30        -4%        2%        31        100        4%        11%        97   

Asia Pacific

    9        13%        22%        9        28        8%        26%        25   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total revenues

    152        -2%        2%        155        477        7%        12%        448   

Expenses:

               

Cloud infrastructure as a service(1)

    87        -1%        2%        87        265        5%        10%        251   

Sales and marketing(1)

    17        -30%        -27%        25        55        -14%        -12%        65   

Stock-based compensation

    1        5%        5%        1        3        2%        2%        3   

Amortization of intangible assets(2)

    1        111%        111%        1        4        534%        534%        1   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total expenses

    106        -6%        -4%        114        327        2%        6%        320   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total Margin

  $ 46        11%        18%      $ 41      $ 150        17%        25%      $ 128   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total Margin %

    30%            26%        31%            29%   

% Revenues by Geography:

               

Americas

    74%            74%        73%            73%   

EMEA

    20%            20%        21%            21%   

Asia Pacific

    6%            6%        6%            6%   

 

(1) 

Excluding stock-based compensation

 

(2) 

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

On a constant currency basis, total cloud IaaS revenues increased in the third quarter and first nine months of fiscal 2016 relative to the corresponding prior year periods primarily due to revenue contributions from our comprehensive software and hardware management, maintenance and hosting services and, for the first nine months of fiscal 2016, incremental revenue contributions from our recent acquisitions that occurred during the first quarter of fiscal 2016. Excluding the effects of currency rate fluctuations, the Americas contributed 21% and 68%, respectively, EMEA contributed 23% and 20%, respectively, and Asia Pacific contributed 56% and 12%, respectively, to the increase in cloud IaaS revenues during the third quarter and first nine months of fiscal 2016, respectively.

On a constant currency basis, total cloud IaaS expenses decreased during the third quarter of fiscal 2016 relative to the prior year period primarily due to a decrease in sales and marketing expenses. Total cloud IaaS expenses increased during the first nine months of fiscal 2016 relative to the corresponding prior year period primarily due to increased employee related expenses associated with increased headcount and increased infrastructure expenses to support our increase in IaaS revenues, the majority of which occurred during the first quarter of fiscal 2016 and was primarily attributable to our recent acquisitions.

 

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Excluding the effects of unfavorable currency exchange variances, total margin and margin as a percentage of revenues increased during the fiscal 2016 periods presented due primarily to the increases in total revenues for this operating segment.

Software License Updates and Product Support:    Software license updates and product support revenues are typically generated through the sale of software support contracts related to on-premise new software licenses purchased by our customers. Our software license updates and product support offerings include software license updates, which grant customers rights to unspecified software product upgrades and maintenance releases and patches released during the support period, and product support including internet access to technical content as well as internet and telephone access to technical support personnel in our global support centers. Expenses associated with our software license updates and product support line of business include the cost of providing the support services, largely personnel related expenses, and the amortization of our intangible assets associated with software support contracts and customer relationships obtained from acquisitions.

 

    Three Months Ended     Nine Months Ended  
    February  29,
2016
    Percent Change     February  28,
2015
    February  29,
2016
    Percent Change     February  28,
2015
 

(Dollars in millions)

    Actual     Constant         Actual     Constant    

Software License Updates and Product Support Revenues:

               

Americas

  $ 2,662        2%        5%      $ 2,613      $ 7,965        3%        6%      $ 7,770   

EMEA

    1,394        -3%        4%        1,437        4,257        -5%        5%        4,503   

Asia Pacific

    613        0%        6%        611        1,826        -3%        7%        1,888   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total revenues

    4,669        0%        5%        4,661        14,048        -1%        6%        14,161   

Expenses:

               

Software license updates and product support(1)

    287        -2%        2%        294        859        1%        8%        852   

Stock-based compensation

    6        -1%        -1%        6        18        18%        18%        15   

Amortization of intangible assets(2)

    131        -22%        -22%        168        413        -27%        -27%        566   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total expenses

    424        -9%        -7%        468        1,290        -10%        -6%        1,433   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total Margin

  $   4,245        1%        6%      $   4,193      $   12,758        0%        7%      $   12,728   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total Margin %

    91%            90%        91%            90%   

% Revenues by Geography:

               

Americas

    57%            56%        57%            55%   

EMEA

    30%            31%        30%            32%   

Asia Pacific

    13%            13%        13%            13%   

 

(1) 

Excluding stock-based compensation

 

(2) 

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

Excluding the effects of unfavorable currency variations of 5 and 7 percentage points in the third quarter and first nine months of fiscal 2016, respectively, software license updates and product support revenues increased by 5% and 6% in the third quarter and first nine months of fiscal 2016, respectively, relative to the corresponding prior year periods as a result of substantially all customers electing to purchase software support contracts in conjunction with their new software licenses purchased during the trailing 4-quarter period, and due to the renewal of substantially all of the software support customer base eligible for renewal during the trailing 4-quarter period. Excluding the effects of currency rate fluctuations, the Americas contributed 58% and 57%, respectively, EMEA contributed 25% and 27%, respectively, and Asia Pacific contributed 17% and 16%, respectively, to the increase in software license updates and product support revenues during the third quarter and first nine months of fiscal 2016, respectively.

Excluding the effects of favorable foreign currency rate fluctuations, total software license updates and product support expenses decreased during the fiscal 2016 periods presented relative to the corresponding prior year periods due to a reduction in expenses associated with certain of our intangible assets that became fully amortized, partially offset by higher other operating expenses including higher bad debt expenses. In addition, we recognized a benefit related to statutory obligations in certain jurisdictions in which we operate that we recorded during the first nine months of fiscal 2015 that reduced our expenses in that period.

Excluding the effects of unfavorable currency rate fluctuations, total margin and margin as a percentage of revenues for this segment increased during the fiscal 2016 periods presented due to the growth in total revenues for this segment and the decrease in amortization of intangible assets.

 

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Hardware Business

Our hardware business consists of our hardware products segment and hardware support segment.

Hardware Products:    Hardware products revenues are primarily generated from the sales of our Oracle Engineered Systems, computer server, storage, networking, workstations and related devices and industry specific hardware products. We market and sell our hardware products through our direct sales force and indirect channels such as independent distributors and value added resellers. Operating expenses associated with our hardware products include the cost of hardware products, which consists of expenses for materials and labor used to produce these products by our internal manufacturing operations or by third-party manufacturers, warranty expenses and the impact of periodic changes in inventory valuation, including the impact of inventory determined to be excess and obsolete. Operating expenses associated with our hardware products also include sales and marketing expenses, which are largely personnel related and include variable compensation earned by our sales force for the sales of our hardware products, and amortization of intangible assets.

 

    Three Months Ended     Nine Months Ended  
    February 29,
2016
    Percent Change     February 28,
2015
    February 29,
2016
    Percent Change     February 28,
2015
 

(Dollars in millions)

    Actual     Constant         Actual     Constant    

Hardware Products Revenues:

               

Americas

  $     289        -23%        -19%      $     375      $     892        -15%        -11%      $     1,051   

EMEA

    192        -6%        2%        203        500        -9%        2%        552   

Asia Pacific

    123        -8%        -3%        134        354        -12%        -5%        404   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total revenues

    604        -15%        -10%        712        1,746        -13%        -6%        2,007   

Expenses:

               

Hardware products(1)

    337        -8%        -1%        366        963        -7%        1%        1,030   

Sales and marketing(1)

    209        -6%        0%        223        648        -3%        6%        665   

Stock-based compensation

    5        16%        16%        5        15        21%        21%        13   

Amortization of intangible assets(2)

    34        -43%        -43%        59        116        -34%        -34%        175   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total expenses

    585        -10%        -5%        653        1,742        -8%        0%        1,883   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total Margin

  $ 19        -68%        -68%      $ 59      $ 4        -96%        -95%      $ 124   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total Margin %

    3%            8%        0%            6%   

% Revenues by Geography:

               

Americas

    48%            53%        51%            52%   

EMEA

    32%            28%        29%            28%   

Asia Pacific

    20%            19%        20%            20%   

 

(1) 

Excluding stock-based compensation

 

(2) 

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

Fiscal Third Quarter 2016 Compared to Fiscal Third Quarter 2015:    Excluding the effects of unfavorable currency rate fluctuations of 5 percentage points, total hardware products revenues decreased in the third quarter of fiscal 2016 due to reductions in sales volumes of certain of our product lines, including lower margin products. On a constant currency basis, hardware products revenues decreased in the Americas and Asia Pacific regions and were offset by hardware products revenues increases in the EMEA region during the fiscal 2016 periods presented.

Excluding the effects of favorable currency rate fluctuations of 5 percentage points, total hardware products expenses decreased in the third quarter of fiscal 2016 primarily due to lower hardware products costs associated with lower hardware products revenues and due to reductions in expenses associated with certain of our intangible assets that became fully amortized.

In constant currency, total margin and total margin as a percentage of revenues decreased in the third quarter of fiscal 2016 as our total revenues decreased at a faster rate than the decrease in our total expenses for this operating segment.

 

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First Nine Months Fiscal 2016 Compared to First Nine Months Fiscal 2015:    Excluding the effects of unfavorable currency rate fluctuations of 7 percentage points, total hardware products revenues decreased in the first nine months of fiscal 2016 due to similar reasons as noted above. This decrease was partially offset by incremental revenues from our recently acquired companies, primarily MICROS, during the first quarter of fiscal 2016. On a constant currency basis, hardware products revenues decreased in the Americas and Asia Pacific regions and were partially offset by hardware products revenues increases in the EMEA region during the first nine months of fiscal 2016.

Excluding the effects of favorable currency rate fluctuations of 8 percentage points, total hardware products expenses were flat in the first nine months of fiscal 2016. During the first nine months of fiscal 2016, we experienced higher hardware products costs that were attributable to an increase in product revenues, primarily from MICROS, during the first quarter of fiscal 2016, which were offset by a reduction in expenses associated with certain of our intangible assets that became fully amortized.

In constant currency, total margin and total margin as a percentage of revenues decreased in the first nine months of fiscal 2016 due to the decrease in our total revenues.

Hardware Support:    Our hardware support offerings provide customers with software updates for software components that are essential to the functionality of our hardware products, such as Oracle Solaris and certain other software products, and can include product repairs, maintenance services and technical support services. Expenses associated with our hardware support operating segment include the cost of materials used to repair customer products, the cost of providing support services, largely personnel related expenses, and the amortization of our intangible assets primarily associated with hardware support contracts and customer relationships obtained from our acquisitions.

 

    Three Months Ended     Nine Months Ended  
    February 29,
2016
    Percent Change     February 28,
2015
    February 29,
2016
    Percent Change     February 28,
2015
 

(Dollars in millions)

    Actual     Constant         Actual     Constant    

Hardware Support Revenues:

               

Americas

  $ 281        -10%        -7%      $ 311      $ 863        -8%        -4%      $ 934   

EMEA

    158        -11%        -4%        176        495        -9%        1%        544   

Asia Pacific

    92        -8%        -2%        100        281        -10%        -1%        313   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total revenues

    531        -10%        -5%        587        1,639        -8%        -2%        1,791   

Expenses:

               

Hardware support(1)

    170        -21%        -17%        216        522        -16%        -11%        624   

Stock-based compensation

    1        -28%        -28%        2        4        -16%        -16%        4   

Amortization of intangible assets(2)

    36        -3%        -3%        38        110        -11%        -11%        123   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total expenses

    207        -19%        -15%        256        636        -15%        -11%        751   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total Margin

  $     324        -3%        3%      $     331      $     1,003        -4%        4%      $     1,040   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total Margin %

    61%            56%        61%            58%   

% Revenues by Geography:

               

Americas

    53%            53%        53%            52%   

EMEA

    30%            30%        30%            30%   

Asia Pacific

    17%            17%        17%            18%   

 

(1) 

Excluding stock-based compensation

 

(2) 

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

Excluding the effects of unfavorable currency rate fluctuations of 5 and 6 percentage points during the third quarter and first nine months of fiscal 2016, respectively, hardware support revenues decreased in the fiscal 2016 periods presented relative to the corresponding prior year periods due to reductions in sales volumes of certain of our hardware product lines for which we offer hardware support. The decrease during the first nine months of fiscal 2016 was partially offset by incremental revenues from our recently acquired companies, primarily MICROS during the first quarter of fiscal 2016. On a constant currency basis, the decrease in hardware support

 

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revenues came from all regions during the third quarter of fiscal 2016 and from the Americas and Asia Pacific regions during the first nine months of fiscal 2016.

Excluding the effects of favorable currency rate fluctuations of 4 percentage points in each of the fiscal 2016 periods presented, total hardware support expenses decreased in the fiscal 2016 periods presented relative to the corresponding prior year periods primarily due to reductions in employee related and other expenses due to reduced headcount and reduced external contractor costs as we integrated MICROS into our operations, and also due to decreases in bad debt expenses. In addition, certain of our intangible assets became fully amortized and reduced expense during the fiscal 2016 periods presented.

In constant currency, total hardware support margin and margin as a percentage of total revenues increased in the fiscal 2016 periods presented due to the expense reductions for this segment.

Services Business

Our services business consists of consulting, advanced customer support services and education services. Consulting revenues are earned by providing services to customers in business and IT strategy alignment, enterprise architecture planning and design, initial software implementation and integration, and ongoing software enhancements and upgrades. Advanced customer support services are provided on-premise and remotely to our customers to enable increased performance and higher availability of their Oracle products and services and also include certain other services. Education revenues are earned by providing instructor-led, live virtual training, self-paced online training, private events and custom training in the use of our software and hardware offerings. The cost of providing our services consists primarily of personnel related expenses, technology infrastructure expenditures, facilities expenses and external contractor expenses.

 

    Three Months Ended     Nine Months Ended  
    February 29,
2016
    Percent Change     February 28,
2015
    February 29,
2016
    Percent Change     February 28,
2015
 

(Dollars in millions)

    Actual     Constant         Actual     Constant    

Services Revenues:

               

Americas

  $ 408        -4%        0%      $ 427      $ 1,289        -2%        3%      $ 1,311   

EMEA

    242        -8%        -1%        265        758        -8%        3%        820   

Asia Pacific

    143        -14%        -9%        166        470        -9%        0%        516   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total revenues

    793        -7%        -2%        858        2,517        -5%        2%        2,647   

Expenses:

               

Services(1)

    650        -9%        -4%        716        2,036        -6%        2%        2,156   

Stock-based compensation

    7        -15%        -15%        8        22        -5%        -5%        23   

Amortization of intangible assets(2)

    2        -70%        -70%        6        6        -63%        -63%        17   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total expenses

    659        -10%        -5%        730        2,064        -6%        1%        2,196   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total Margin

  $     134        6%        12%      $     128      $     453        0%        10%      $     451   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total Margin%

    17%            15%        18%            17%   

% Revenues by Geography:

               

Americas

    51%            50%        51%            50%   

EMEA

    31%            31%        30%            31%   

Asia Pacific

    18%            19%        19%            19%   

 

(1) 

Excluding stock-based compensation

 

(2) 

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

Fiscal Third Quarter 2016 Compared to Fiscal Third Quarter 2015:    Excluding the effects of unfavorable currency rate fluctuations of 5 percentage points, our total services revenues decreased during the third quarter of fiscal 2016 due primarily to revenue decreases in our consulting segment partially offset by increases in our advanced customer support segment of which the majority of the growth was attributable to our recent acquisitions.

 

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Excluding the effects of favorable currency rate fluctuations, our total services expenses decreased during the third quarter of fiscal 2016 primarily due to a decrease in employee related expenses and lower external contractor costs.

In constant currency, total services margin and total margin as a percentage of total services revenues increased during the third quarter of fiscal 2016 as our total costs decreased at a faster rate than our total revenues for this business.

First Nine Months Fiscal 2016 Compared to First Nine Months Fiscal 2015:    Excluding the effects of unfavorable currency rate fluctuations of 7 percentage points, our total services revenues increased during the first nine months of fiscal 2016 due primarily to revenue increases in our advanced customer support segment of which the majority of the growth was attributable to our recent acquisitions.

Excluding the effects of favorable currency rate fluctuations of 7 percentage points, our total services expenses increased slightly in the first nine months of fiscal 2016 due to an increase in employee related expenses and higher external contractor costs, both of which were primarily attributable to incremental contributions from MICROS during our first quarter of fiscal 2016.

In constant currency, total services margin and total margin as a percentage of total services revenues increased during the first nine months of fiscal 2016 as total revenues increased at a faster rate than the increase in our total expenses for this business.

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     Nine Months Ended  
    February 29,
2016
    Percent Change     February 28,
2015
    February 29,
2016
    Percent Change     February 28,
2015
 

(Dollars in millions)

    Actual     Constant         Actual     Constant    

Research and development(1)

  $ 1,265        3%        5%      $ 1,232      $ 3,801        2%        5%      $ 3,708   

Stock-based compensation

    154        11%        11%        138        452        19%        19%        380   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total expenses

  $     1,419        4%        5%      $     1,370      $     4,253        4%        6%      $     4,088   
 

 

 

       

 

 

   

 

 

       

 

 

 

% of Total Revenues

    16%            15%        16%            15%   

 

(1) 

Excluding stock-based compensation

On a constant currency basis, total research and development expenses increased during the fiscal 2016 periods presented relative to the corresponding prior year periods primarily due to increased employee related expenses resulting from increased headcount, including additional headcount from our recent acquisitions, and also due to increased infrastructure expenses.

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     Nine Months Ended  
    February  29,
2016
    Percent Change     February  28,
2015
    February  29,
2016
    Percent Change     February  28,
2015
 

(Dollars in millions)

    Actual     Constant         Actual     Constant    

General and administrative(1)

  $ 261        17%        22%      $ 223      $ 746        9%        15%      $ 683   

Stock-based compensation

    29        -1%        -1%        29        86        -26%        -26%        116   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total expenses

  $     290        15%        20%      $     252      $     832        4%        9%      $     799   
 

 

 

       

 

 

   

 

 

       

 

 

 

% of Total Revenues

    3%            3%        3%            3%   

 

(1) 

Excluding stock-based compensation

On a constant currency basis, total general and administrative expenses increased during the fiscal 2016 periods presented relative to the corresponding prior year periods primarily due to increased salaries expenses resulting from increased headcount and due to higher professional services expenses, primarily legal related expenses.

 

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Table of Contents

Amortization of Intangible Assets:    Substantially all of our intangible assets are acquired through our business combinations. We amortize our intangible assets over, and monitor the appropriateness of, the estimated useful lives of these assets. We also periodically review these intangible assets for potential impairment based upon relevant facts and circumstances. Note 5 of Notes to Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report has additional information regarding our intangible assets and related amortization.

 

    Three Months Ended     Nine Months Ended  
    February  29,
2016
    Percent Change     February  28,
2015
    February  29,
2016
    Percent Change     February  28,
2015
 

(Dollars in millions)

    Actual     Constant         Actual     Constant    

Software support agreements and related relationships

  $     93        -21%        -21%      $     117      $     297        -28%        -28%      $     412   

Hardware support agreements and related relationships

    37        0%        0%        37        109        0%        0%        109   

Developed technology

    134        -25%        -25%        179        427        -19%        -19%        526   

Core technology

    23        -47%        -47%        43        70        -52%        -52%        147   

Customer relationships and contract backlog

    54        -33%        -33%        80        177        -25%        -25%        237   

SaaS, PaaS and IaaS agreements and related relationships and other

    53        2%        2%        52        160        7%        7%        150   

Trademarks

    14        -26%        -26%        19        43        -30%        -30%        61   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total amortization of intangible assets

  $ 408        -23%        -23%      $ 527      $ 1,283        -22%        -22%      $ 1,642   
 

 

 

       

 

 

   

 

 

       

 

 

 

Amortization of intangible assets decreased during the fiscal 2016 periods presented due to a reduction in expenses associated with certain of our intangible assets that became fully amortized. These decreases were partially offset by additional amortization from intangible assets that we acquired in connection with our recent acquisitions.

Acquisition Related and Other Expenses:    Acquisition related and other expenses consist of personnel related costs for transitional and certain other employees, stock-based compensation expenses, integration related professional services, certain business combination adjustments including certain adjustments after the measurement period has ended and certain other operating items, net. Stock-based compensation expenses included in acquisition related and other expenses resulted from unvested stock options and restricted stock-based awards assumed from acquisitions whereby vesting was accelerated upon termination of the employees pursuant to the original terms of those stock options and restricted stock-based awards.

 

    Three Months Ended     Nine Months Ended  
    February  29,
2016
    Percent Change     February  28,
2015
    February  29,
2016
    Percent Change     February  28,
2015
 

(Dollars in millions)

    Actual     Constant         Actual     Constant    

Transitional and other employee related costs

  $     8        -45%        -43%      $     14      $ 40        -11%        -10%      $     46   

Stock-based compensation

           -100%        -100%        1        3        -43%        -43%        5   

Professional fees and other, net

    1        115%        118%        (7     10        125%        125%        (39

Business combination adjustments, net

    2        824%        726%               (18     *           *             
 

 

 

       

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total acquisition related and other expenses

  $ 11        38%        42%      $ 8      $     35        201%        226%      $ 12   
 

 

 

       

 

 

   

 

 

       

 

 

 

 

* 

Not meaningful

Fiscal Third Quarter 2016 Compared to Fiscal Third Quarter 2015:    On a constant currency basis, the increase in acquisition related and other expenses during the third quarter of fiscal 2016 relative to the prior year period was primarily due to higher professional fees and other costs, net.

First Nine Months Fiscal 2016 Compared to First Nine Months Fiscal 2015:    On a constant currency basis, the increase in acquisition related and other expenses during the first nine months of fiscal 2016 relative to the prior year period was primarily due to a $53 million benefit related to certain litigation that we recorded during the first nine months of fiscal 2015, which decreased acquisition related and other expenses in that period. We also recorded an acquisition related benefit of $19 million during the first nine months of fiscal 2016, which reduced our expenses during such period.

 

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Restructuring Expenses:    Restructuring expenses result from the execution of management approved restructuring plans that were generally developed to improve our cost structure and/or operations, often in conjunction with our acquisition integration strategies. Restructuring expenses consist of employee severance costs and may also include charges for duplicate facilities and other contract termination costs to improve our cost structure prospectively. For additional information regarding our restructuring plans, see Note 6 of Notes to Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report.

 

    Three Months Ended     Nine Months Ended  
    February  29,
2016
    Percent Change     February  28,
2015
    February  29,
2016
    Percent Change     February  28,
2015
 

(Dollars in millions)

    Actual     Constant         Actual     Constant    

Restructuring expenses

  $ 115        141%        157%      $ 48      $ 293        74%        100%      $ 168   
 

 

 

       

 

 

   

 

 

       

 

 

 

Restructuring expenses in the fiscal 2016 periods presented primarily related to our 2015 Restructuring Plan. Restructuring expenses in the fiscal 2015 periods presented primarily related to our 2015 Restructuring Plan and our 2013 Restructuring Plan. Our management approved, committed to and initiated these plans in order to restructure and further improve efficiencies in our operations. The total estimated restructuring costs associated with the 2015 Restructuring Plan are up to $525 million and will be recorded to the restructuring expense line item within our consolidated statements of operations as they are incurred. The total estimated remaining restructuring costs associated with the 2015 Restructuring Plan were approximately $125 million as of February 29, 2016 and the majority of the remaining costs are expected to be incurred through the end of fiscal 2016. Actions pursuant to the 2013 Restructuring Plan were substantially complete as of May 31, 2015 (Note 9 of Notes to Consolidated Financial Statements as included in our Annual Report on Form 10-K for our fiscal year ended May 31, 2015 contains additional information pertaining to our 2013 Restructuring Plan). Our estimated costs are subject to change in future periods.

Interest Expense:

 

    Three Months Ended     Nine Months Ended  
    February  29,
2016
    Percent Change     February  28,
2015
    February  29,
2016
    Percent Change     February  28,
2015
 

(Dollars in millions)

    Actual     Constant         Actual     Constant    

Interest expense

  $ 360        32%        32%      $ 273      $ 1,105        35%        35%      $ 817   
 

 

 

       

 

 

   

 

 

       

 

 

 

Interest expense increased in the fiscal 2016 periods presented due to higher average borrowings resulting from our issuance of $10.0 billion of senior notes in May 2015. We also issued $10.0 billion of senior notes in July 2014, which contributed to additional interest expense during the first nine months of fiscal 2016 relative to the corresponding prior year period. These increases in interest expense during the fiscal 2016 periods presented were partially offset by reductions in interest expense resulting from the maturity and repayment of $2.0 billion of senior notes in January 2016. Interest expense was also reduced in the first nine months of fiscal 2016 relative to the corresponding prior year period by the maturity and repayment of $1.5 billion of senior notes and the related fixed to variable interest rate swap agreements in July 2014.

 

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Non-Operating Income, net:    Non-operating income, net consists primarily of interest income, net foreign currency exchange gains (losses), the noncontrolling interests in the net profits of our majority-owned subsidiaries (primarily Oracle Financial Services Software Limited and Oracle Japan) and net other income (losses), including net realized gains and losses related to all of our investments and net unrealized gains and losses related to the small portion of our investment portfolio that we classify as trading.

 

    Three Months Ended     Nine Months Ended  
    February  29,
2016
    Percent Change     February  28,
2015
    February  29,
2016
    Percent Change     February  28,
2015
 

(Dollars in millions)

    Actual     Constant         Actual     Constant    

Interest income

  $ 141        73%        77%      $ 82      $ 382        53%        59%      $ 250   

Foreign currency losses, net

    (15     -52%        -82%        (32     (68     -35%        -49%        (105

Noncontrolling interests in income

    (36     106%        106%        (17     (95     -5%        -5%        (100

Other (loss) income, net

    (25     441%        444%        7        (40     296%        299%        20   
 

 

 

       

 

 

   

 

 

       

 

 

 

Total non-operating income, net

  $ 65        62%        86%      $ 40      $ 179        174%        228%      $ 65   
 

 

 

       

 

 

   

 

 

       

 

 

 

On a constant currency basis, our non-operating income, net for the fiscal 2016 periods presented increased due to higher interest income resulting from higher interest rates and higher cash, cash equivalent and short-term investment balances and due to lower net foreign currency losses.

Provision for Income Taxes:    Our 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 U.S. federal statutory income tax rate due primarily to certain earnings considered as indefinitely reinvested in foreign operations, state taxes, the U.S. research and development tax credit, settlements with tax authorities and the U.S. domestic production activity deduction. Future effective tax rates could be adversely affected if earnings are lower than anticipated in countries where we have lower statutory tax rates, by unfavorable changes in tax laws and regulations or by adverse rulings in tax related litigation.

 

    Three Months Ended     Nine Months Ended  
    February  29,
2016
    Percent Change     February  28,
2015
    February  29,
2016
    Percent Change     February  28,
2015
 

(Dollars in millions)

    Actual     Constant         Actual     Constant    

Provision for income taxes

  $ 590        -10%        -3%      $ 655      $ 1,623        -17%        -8%      $ 1,956   
 

 

 

       

 

 

   

 

 

       

 

 

 

Effective tax rate

    21.6%            20.8%        21.0%            21.4%   

Fiscal Third Quarter 2016 Compared to Fiscal Third Quarter 2015:    Provision for income taxes in the third quarter of fiscal 2016 decreased, relative to the provision for income taxes during the third quarter of fiscal 2015, due in substantial part to lower net income before provision for income taxes during the third quarter of fiscal 2016, as well as the retroactive permanent extension of the U.S. research and development credit, partially offset by unfavorable changes in the jurisdictional mix of our earnings during the third quarter of fiscal 2016.

First Nine Months Fiscal 2016 Compared to First Nine Months Fiscal 2015:    Provision for income taxes in the first nine months of fiscal 2016 decreased, relative to the provision for income taxes during the first nine months of fiscal 2015, due in substantial part to lower net income before provision for income taxes during the first nine months of fiscal 2016, as well as settlements with certain tax authorities, partially offset by unfavorable changes in the jurisdictional mix of our earnings during the first nine months of fiscal 2016.

Liquidity and Capital Resources

 

(Dollars in millions)

   February 29,
2016
     Change      May 31,
2015
 

Working capital

   $ 45,244         -4%       $ 47,314   

Cash, cash equivalents and marketable securities

   $ 50,767         -7%       $ 54,368   

Working capital:    The decrease in working capital as of February 29, 2016 in comparison to May 31, 2015 was primarily due to cash used for repurchases of our common stock, cash used to pay dividends to our stockholders

 

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and cash used for capital expenditures during the first nine months of fiscal 2016. These unfavorable working capital movements were partially offset by the favorable impacts to our net current assets resulting from our net income during the first nine months of fiscal 2016. Our working capital may be impacted by some or all of the aforementioned factors in future periods, the amounts and timing of which are variable.

Cash, cash equivalents and marketable securities:    Cash and cash equivalents primarily consist of deposits held at major banks, Tier-1 commercial paper and other securities with original maturities of 90 days or less. Marketable securities consist of Tier-1 commercial paper debt securities, corporate debt securities and certain other securities. The decrease in cash, cash equivalents and marketable securities at February 29, 2016 in comparison to May 31, 2015 was primarily due to repurchases of our common stock, the repayment of $2.0 billion of senior notes, the payment of cash dividends to our stockholders, and cash used for capital expenditures, all of which occurred during the first nine months of fiscal 2016. These decreases to our cash, cash equivalents and marketable securities were partially offset by cash flows generated from our operations and, to a lesser extent, cash inflows from stock option exercises, both of which occurred during the first nine months of fiscal 2016. Cash, cash equivalents and marketable securities included $46.8 billion held by our foreign subsidiaries as of February 29, 2016, a significant portion of which was generated from the earnings of these foreign subsidiaries that we consider as indefinitely reinvested in our foreign operations outside the United States. These undistributed earnings that are considered as indefinitely reinvested overseas would be subject to U.S. income tax if repatriated to the United States. The amount of cash, cash equivalents and marketable securities that we report in U.S. Dollars for a significant portion of the cash, cash equivalents and marketable securities balances held by our foreign subsidiaries is subject to translation adjustments caused by changes in foreign currency exchange rates as of the end of each respective reporting period (the offset to which is substantially recorded to accumulated other comprehensive loss in our consolidated balance sheets and is also presented as a line item in our condensed consolidated statements of comprehensive income included elsewhere in this Quarterly Report). As the U.S. Dollar generally strengthened against certain major international currencies during the first nine months of fiscal 2016, the amount of cash, cash equivalents and marketable securities that we reported in U.S. Dollars for these subsidiaries decreased on a net basis as of February 29, 2016 relative to what we would have reported using constant currency rates from our May 31, 2015 balance sheet date.

Days sales outstanding, which we calculate by dividing period end accounts receivable by average daily sales for the quarter, was 38 days at February 29, 2016 compared with 47 days at May 31, 2015. The days sales outstanding calculation excludes the impact of any revenue adjustments resulting from business combinations that reduced our acquired cloud SaaS and PaaS obligations, software license updates and product support obligations and hardware support obligations to fair value. The decline in days sales outstanding was primarily due to strong collections in our first nine months of fiscal 2016 and seasonality resulting in a large volume of software license, hardware products and software support balances outstanding as of May 31, 2015.

 

     Nine Months Ended  

(Dollars in millions)

   February 29,
2016
    Change      February 28,
2015
 

Net cash provided by operating activities

   $ 9,831        -2%       $ 10,053   

Net cash used for investing activities

   $ (4,026     -74%       $ (15,323

Net cash (used for) provided by financing activities

   $ (11,689     636%       $ 2,182   

Cash flows from operating activities:    Our largest source of operating cash flows is cash collections from our customers following the purchase and renewal of their software license updates and product support agreements. Payments from customers for these support agreements are generally received near the beginning of the contracts’ terms, which are generally one year in length. Over the course of a fiscal year, we also have historically generated cash from the sales of new software licenses, cloud SaaS and PaaS offerings, hardware products, hardware support arrangements, and services. Our primary uses of cash from operating activities are for employee related expenditures, material and manufacturing costs related to the production of our hardware products, taxes and leased facilities.

 

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Net cash provided by operating activities decreased in the first nine months of fiscal 2016 in comparison to the first nine months of fiscal 2015 primarily due to the cash unfavorable effects of lower net income and the related unfavorable foreign currency exchange rate variances of 9 percentage points on our net income during the first nine months of fiscal 2016. These decreases during the first nine months of fiscal 2016 were partially offset by cash favorable changes in certain working capital items relative to the changes for these items in the corresponding prior year period.

Cash flows from investing activities:    The changes in cash flows from investing activities primarily relate to our acquisitions, the timing of our purchases, maturities and sales of our investments in marketable debt securities and investments in capital and other assets, including certain intangible assets, to support our growth.

Net cash used for investing activities decreased in the first nine months of fiscal 2016 primarily due to a decrease in cash used for acquisitions, net of cash acquired, and a decrease in net cash used to purchase marketable securities (net of proceeds received from sales and maturities) relative to the corresponding changes for these items in the prior year period. These decreases were partially offset by an increase in capital expenditures to support our cloud offerings and research and development functions.

Cash flows from financing activities:    The changes in cash flows from financing activities primarily relate to borrowings and repayments related to our debt instruments as well as stock repurchases, dividend payments and net proceeds related to employee stock programs.

We used net cash for financing activities of $11.7 billion during the first nine months of fiscal 2016 in comparison to net cash provided by financing activities of $2.2 billion during the first nine months of fiscal 2015. The change in financing activities cash flows during the first nine months of fiscal 2016 in comparison to the first nine months of fiscal 2015 was primarily related to $8.4 billion of net cash inflows from debt issuances, net of debt repayments, during the first nine months of fiscal 2015 in comparison to $2.0 billion of net cash outflows related to debt settlements during the first nine months of fiscal 2016. In addition, we also increased our stock repurchase activity during the first nine months of fiscal 2016, which increased our cash used in the fiscal 2016 period relative to the corresponding prior year period.

Free cash flow:    To supplement our statements of cash flows presented on a GAAP basis, we use non-GAAP measures of cash flows on a trailing 4-quarter basis to analyze cash flows generated from our operations. We believe free cash flow is also useful as one of the bases for comparing our performance with our competitors. The presentation of non-GAAP free cash flow is not meant to be considered in isolation or as an alternative to net income as an indicator of our performance, or as an alternative to cash flows from operating activities as a measure of liquidity. We calculate free cash flows as follows:

 

     Trailing 4-Quarters Ended  

(Dollars in millions)

   February 29,
2016
    Change      February 28,
2015
 

Net cash provided by operating activities

   $ 14,114        -3%       $ 14,509   

Capital expenditures

     (1,606     69%         (948
  

 

 

      

 

 

 

Free cash flow

   $ 12,508        -8%       $ 13,561   
  

 

 

      

 

 

 

Net income

   $ 8,844         $ 10,827   
  

 

 

      

 

 

 

Free cash flow as percent of net income

     141%           125%   

Long-Term Customer Financing:    We offer certain of our customers the option to acquire our software products, hardware products and services offerings through separate long-term payment contracts. We generally sell these contracts that we have financed for our customers on a non-recourse basis to financial institutions within 90 days of the contracts’ dates of execution. We record the transfers of amounts due from customers to financial institutions as sales of financing receivables because we are considered to have surrendered control of these financing receivables. We financed $548 million and $864 million, respectively, or approximately 12% and 16%, respectively, of our new software licenses revenues in the first nine months of fiscal 2016 and 2015, and $102 million and $103 million, respectively, or approximately 6% and 5%, respectively, of our hardware products revenues in the first nine months of fiscal 2016 and 2015.

 

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Recent Financing Activities:

Common Stock Repurchases: Our Board of Directors has approved a program for us to repurchase shares of our common stock. On March 15, 2016, we announced that our Board of Directors approved an expansion of our stock repurchase program by an additional $10.0 billion. As of February 29, 2016, approximately $809 million remained available for stock repurchases pursuant to our stock repurchase program prior to the March 2016 program expansion. Our stock repurchase authorization does not have an expiration date and the pace of our repurchase activity will depend on factors such as our working capital needs, our cash requirements for acquisitions and dividend payments, our debt repayment obligations or repurchases of our debt, our stock price, and economic and market conditions. Our stock repurchases may be effected from time to time through open market purchases or pursuant to a Rule 10b5-1 plan. Our stock repurchase program may be accelerated, suspended, delayed or discontinued at any time.

Senior Notes: In January 2016, our $2.0 billion of 5.25% senior notes due January 2016 matured and were repaid.

Contractual Obligations:    During the first nine months of fiscal 2016, there were no significant changes to our estimates of future payments under our fixed contractual obligations and commitments as presented in Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for our fiscal year ended May 31, 2015.

We believe that our current cash, cash equivalents and marketable securities and cash generated from operations will be sufficient to meet our working capital, capital expenditures and contractual obligation requirements. In addition, we believe we could fund any future acquisitions, dividend payments and repurchases of common stock or debt with our internally available cash, cash equivalents and marketable securities, cash generated from operations, additional borrowings or from the issuance of additional securities.

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

Stock Options and Restricted Stock-Based Awards

Our stock-based compensation program is a key component of the compensation package we provide to attract and retain certain of our talented employees and align their interests with the interests of existing stockholders.

We recognize that stock options and restricted stock-based awards dilute existing stockholders and have sought to control the number of stock options and restricted stock-based awards granted while providing competitive compensation packages. Consistent with these dual goals, our cumulative potential dilution since June 1, 2012 has been a weighted average annualized rate of 1.6% per year. The potential dilution percentage is calculated as the average annualized new stock options or restricted stock-based awards granted and assumed, net of stock options and restricted stock-based awards forfeited by employees leaving the company, divided by the weighted average outstanding shares during the calculation period. This maximum potential dilution will only result if all stock options are exercised and restricted stock-based awards vest. Of the outstanding stock options at February 29, 2016, which generally have a 10-year exercise period, 13.8% have exercise prices higher than the market price of our common stock on such date. In recent years, our stock repurchase program has more than offset the dilutive effect of our stock-based compensation program; however, we may reduce the level of our stock repurchases in the future as we may use our available cash for acquisitions, to pay dividends, to repay or repurchase indebtedness or for other purposes. At February 29, 2016, the maximum potential dilution from all outstanding and unexercised stock options and restricted stock-based awards, regardless of when granted and regardless of whether vested or unvested and including stock options where the strike price is higher than the market price as of such date, was 10.8%.

 

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Recent Accounting Pronouncements

For information with respect to recent accounting pronouncements, if any, and the impact of these pronouncements on our consolidated financial statements, if any, see Note 1 of Notes to Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report.

Item 3.    Quantitative and Qualitative Disclosures About Market Risk

There were no significant changes to our quantitative and qualitative disclosures about market risk during the first nine months of fiscal 2016. Please refer to Part II, Item 7A. Quantitative and Qualitative Disclosures about Market Risk included in our Annual Report on Form 10-K for our fiscal year ended May 31, 2015 for a more complete discussion of the market risks we encounter.

Item 4.    Controls and Procedures

Evaluation of Disclosure Controls and Procedures:    Based on our management’s evaluation (with the participation of our Principal Executive Officers, one of whom is our Principal Financial Officer), as of the end of the period covered by this Quarterly Report, our Principal Executive Officers have concluded that our “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) were effective to provide reasonable assurance that the information required to be disclosed by us in our reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms and is accumulated and communicated to our management (including our Principal Executive Officers) as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting:    There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls:    Our management, including our Principal Executive Officers, one of whom is our Principal Financial Officer, believes that our disclosure controls and procedures and internal control over financial reporting are designed to provide reasonable assurance of achieving their objectives and are effective at the reasonable assurance level. However, our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well-conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost effective control system, misstatements due to error or fraud may occur and not be detected.

 

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PART II. OTHER INFORMATION

Item 1.    Legal Proceedings

The material set forth in Note 13 of Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q is incorporated herein by reference.

Item 1A.    Risk Factors

In addition to the other information set forth in this Quarterly Report, you should carefully consider the factors discussed in Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for our fiscal year ended May 31, 2015. The risks discussed in our Annual Report on Form 10-K could materially affect our business, financial condition and future results. The risks described in our Annual Report on Form 10-K are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be insignificant also may materially and adversely affect our business, financial condition or operating results in the future.

Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds

Our Board of Directors has approved a program for us to repurchase shares of our common stock. On March 15, 2016, we announced that our Board of Directors approved an expansion of our stock repurchase program by an additional $10.0 billion. As of February 29, 2016, approximately $809 million remained available for stock repurchases pursuant to our stock repurchase program prior to the March 2016 program expansion.

Our stock repurchase authorization does not have an expiration date and the pace of our repurchase activity will depend on factors such as our working capital needs, our cash requirements for acquisitions and dividend payments, our debt repayment obligations or repurchases of our debt, our stock price, and economic and market conditions. Our stock repurchases may be effected from time to time through open market purchases or pursuant to a Rule 10b5-1 plan. Our stock repurchase program may be accelerated, suspended, delayed or discontinued at any time.

The following table summarizes the stock repurchase activity for the three months ended February 29, 2016 and the approximate dollar value of shares that may yet be purchased pursuant to our stock repurchase program:

 

(in millions, except per share amounts)

  Total Number of
Shares
Purchased
    Average
Price Paid
  per Share  
    Total Number of
Shares Purchased as
Part of Publicly
Announced
Program
    Approximate Dollar
Value of Shares that
May Yet Be
Purchased
Under the Program
 

December 1, 2015—December 31, 2015

    19.1      $ 37.69        19.1      $ 2,276.4   

January 1, 2016—January 31, 2016

    23.3      $ 34.85        23.3      $ 1,464.8   

February 1, 2016—February 29, 2016

    18.2      $ 36.07        18.2      $ 809.0   
 

 

 

     

 

 

   

Total

    60.6      $ 36.11        60.6     
 

 

 

     

 

 

   

 

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Item 6.    Exhibits

 

Exhibit
No.
  

Exhibit Description

  Incorporated by Reference
     Form       File No.       Exhibit   Filing Date       Filed By    
31.01‡    Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer          
31.02‡    Rule 13a-14(a)/15d-14(a) Certification of Principal Executive and Financial Officer          
32.01†    Section 1350 Certification of Principal Executive Officers and Principal Financial Officer          
101‡    Interactive Data Files Pursuant to Rule 405 of Regulation S-T: (i) Condensed Consolidated Balance Sheets as of February 29, 2016 and May 31, 2015, (ii) Condensed Consolidated Statements of Operations for the three and nine months ended February 29, 2016 and February 28, 2015, (iii) Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended February 29, 2016 and February 28, 2015, (iv) Condensed Consolidated Statements of Cash Flows for the nine months ended February 29, 2016 and February 28, 2015 and (v) Notes to Condensed Consolidated Financial Statements          

 

Filed herewith.

 

Furnished herewith.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, Oracle Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    ORACLE CORPORATION

Date: March 18, 2016

    By:    

/s/    SAFRA A. CATZ        

      Safra A. Catz
     

Chief Executive Officer and Director

(Principal Executive and Financial Officer)

Date: March 18, 2016

    By:    

/s/    WILLIAM COREY WEST        

      William Corey West
     

Executive Vice President, Corporate Controller

and Chief Accounting Officer

 

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