Why It's Tough To Know What Oracle Earned

| About: Oracle Corporation (ORCL)

Oracle Corporation (NASDAQ:ORCL) announced a growing profit on lower sales in the first fiscal quarter - but who really knows what happened? As CEO Larry Ellison and his team struggle against numerous challenges, they're pushing into cloud computing and promising better times ahead. But several warning signs suggest that they could have fudged the California software company's earnings numbers.

Oracle said on September 20 that its sales fell 2% to $8.2 billion during the three months ended August 31 compared to the same period last year, but its profit gained by 11% year over year to $2.03 billion. Oracle's hardware sales fell as governments tighten their technology spending budgets.

Meanwhile, the company has struggled to benefit from its 2009 acquisition of the computer server company Sun Microsystems for around $7.4 billion, which even Keith Block, Oracle's former executive vice president of North America sales and consulting, had called "a dog" in instant messages that became public recently.

Oracle is, however, betting on a shift into cloud computing. Its president and CFO Safra Catz noted growth in Oracle's new software licenses and cloud software subscriptions on a non-Generally Accepted Accounting Principles basis during the recent quarter.

On a conference call, Ms. Catz said the company's as-reported results partially masked the underlying strength of the business because the U.S. dollar strengthened over the last year. She also suggested better times ahead by saying that Oracle's new software license and cloud subscription revenue will range from 5% to 15%.

Oracle combined its software licenses and cloud software subscription revenue to create a new sales number, out of which it would break out cloud revenue. But Oracle won't break out expenses because the same sales organization and the same development organization make up the bulk of the expenses in both its on-premise software and cloud offering, Ms. Catz said.

More detail about Oracle's expenses would be nice, particularly considering that the trailing twelve month average of the company's total sales as of May 31 amounted to $37.1 billion, or around 1.6 times its expenses versus the industry median of 1.1. Either Oracle incurs less expense than its rivals to generate its sales, or the company is doing something different in the way it recognizes revenue.

Interestingly, Oracle's numbers don't suggest efficiency when it comes to prepaid expenses. For example, if a company pays upfront for services that last over five years, they would be assets until they become fully consumed, when they are expensed. The average of Oracle's prepaid expenses amounted to $1.8 billion as of May 31, or almost 8% of its total expenses versus the industry median of more than 3%.

Meanwhile, Oracle has managed to grow its earnings per share every year since 2002 - a rare and incredible performance, particularly considering the numerous challenges that CEO Ellison and his team have faced.

Those are just some of the red flags about Oracle's accounting. In a glaring sign of integrity issues, CEO Ellison hired his buddy Mark Hurd as president and director at Oracle in 2010 after Hurd left his job as CEO of Hewlett-Packard Co. in the face of a sexual harassment scandal.

Oracle has also had its own run-ins with the law over the years - for example, the Justice Department said in October 2011 that the company agreed to pay more than $199.5 million for allegedly failing to meet its contractual obligations to provide the General Services Administration with accurate information about its sales practices.

CEO Ellison could have the leeway to make whatever trouble he wants, as his supervisors don't seem particularly capable of objective oversight. Eight of those on the twelve-person board have served for more than ten years, with the exceptions including Hurd; while experience has its merits, long familiarity with the management can make it tougher for supervisors to see and correct mistakes.

The chair of the finance and audit committee is 82-year-old Donald L. Lucas, a self-employed venture capitalist who has been on the board since March 1980. H. Raymond Bingham, who chairs both the finance & audit and the independence committees, seems to have his hands full with many additional duties, as he also currently serves as a director of Flextronics International, Spansion Inc., Dice Holdings, Inc., STMicroelectronics N.V. and Fusion-io, Inc.

Indications are that these managers do look the other way. Despite a $1 base salary, CEO Ellison earned $14.9 million in fiscal 2011 - including more than $1.5 million in security-related costs for Mr. Ellison's residence. Over the years until the end of fiscal 2011, Ellison had accumulated 44.4 million outstanding market-priced stock options worth around $649.6 million as of Friday.

In part due to such warning signs, Oracle's financial results data gives it an AGR score of 9, indicating higher accounting and governance risk than 91% of companies. Its ESG rating is an F.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by a financial reporter at GMI. The reporter has no business relationship with any company whose stock is mentioned in this article. Nobody paid GMI to write this article on his or her behalf.

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