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several factors contributed to this poor performance. First, the company had recently re-
drawn its sales territories and, as a result, for several months salespeople had become
unsure of their new responsibilities, leaving some customers dissatis¬ed. Second, there
were problems with a number of new products, such as Oracle Financials, which were
released before all major bugs could be ¬xed. However, the stock market was unim-
pressed by these explanations, and the ¬rm™s stock price dropped by 31 percent with the
earnings announcement.


REVENUE RECOGNITION
The deterioration in its ¬nancial performance prompted analysts to question Oracle™s
method of recognizing revenues. For example, one analyst commented:
Oracle™s accounting practices might have played a role in the low net income re-
sults. The top line went up over 50%, though the net bottom line did not do so well,
because Oracle™s running more cash than it should be as a result of ¬nancial mis-
management. The company™s aggressive revenue-recognition policy and relatively
high amount of accounts receivables make the stock risky.
239
Revenue Analysis




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Oracle™s major revenues come from licensing software products to end users, and
from sublicensing agreements with original equipment manufacturers (OEMs) and soft-
ware value-added relicensors (VARs). Initial license fees for the ORACLE database man-
agement system range from $199 to over $5,500 on micro- and personal computers, and
from $5,100 to approximately $342,000 on mini- and mainframe computers. License
fees for Oracle Financial and Oracle Government Financial products range from
Oracle Systems Corporation




$20,000 to $513,000, depending on the platform and number of users. A customer may
obtain additional licenses at the same site at a discount. Oracle recognizes revenues from
these licenses when a contract has been signed with a ¬nancially sound customer, even
though shipment of products has not occurred.
OEM agreements are negotiated on a case-by-case basis. However, under a typical
contract Oracle receives an initial nonrefundable fee (payable either upon signing the
contract or within 30 days of signing) and sublicense fees based on the number of copies
distributed. Under VAR agreements the company charges a development license fee on
top of the initial nonrefundable fee, and it receives sublicense fees based on the number
of copies distributed. Sublicense fees are usually a percentage of Oracle™s list price. The
initial nonrefundable payments and development license fees under these arrangements
are recorded as revenue when the contracts are signed. Sublicense fees are recorded
when they are received from the OEM or VAR.
Oracle also receives revenues from maintenance agreements under which it provides
technical support and telephone consultation on the use of the products and problem res-
olution, system updates for software products, and user documentation. Maintenance
fees generally run for one year and are payable at the end of the maintenance period.
They range from 7.5 percent to 22 percent of the current list price of the appropriate
license. These fees are recorded as unearned revenue when the maintenance contract is
signed and are re¬‚ected as revenue ratably over the contract period.
The major questions about Oracle™s revenue recognition concern the way the ¬rm
recognizes revenues on license fees. There is no currently accepted standard for ac-
counting for these types of revenues.1 However, Oracle tends to be one of the more ag-
gressive reporters. The ¬rm™s days receivable exceeds 160 days, substantially higher
than the average of 62 days receivable for other software developers (see Exhibit 3 for a
summary of days receivable for other major software developers in 1989 and 1990). As
a result, some analysts argue that the ¬rm should recognize revenue when software is
delivered rather than when a contract is signed, consistent with the accounting treatment
for the sale of products. In addition, the collectibility of license fees is considered ques-
tionable by some analysts, who have urged the ¬rm to recognize revenue only when
there is a reasonable basis for estimating the degree of collectibility of a receivable. Es-
timates by Oracle™s controller indicate that if Oracle were to change to a more conserva-
tive revenue recognition policy, the ¬rm™s days receivable would fall to about 120 days.

.........................................................................................................................
1. The Financial Accounting Standards Board was considering the issue of revenue recognition for software develop-
ers at this time. It was widely expected that the Board would make a pronouncement on the topic early in 1991.
240 Revenue Analysis




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Revenue Analysis




MANAGEMENT™S CONCERNS
Oracle™s management was concerned about analysts™ opinions and the downturn in the
¬rm™s stock. The company had lost credibility with investors and customers due to its
recent poor performance and its controversial accounting policies.
One of the items on the agenda at the upcoming board meeting was to consider pro-




Oracle Systems Corporation
posals for changing the ¬rm™s revenue recognition method and for dealing with its com-
munication challenge. Ellison knew that his opinion on this question would be
in¬‚uential. As he saw it, the company had three alternatives. One was to modify the rec-
ognition of license fees so that revenue would be recognized only when substantially all
the company™s contractual obligations had been performed. However, he worried that
such a change would have a negative impact on the ¬rm™s bottom line and further de-
press the stock price. A second possibility was to wait until the FASB announced its po-
sition on software revenue recognition before making any changes. Finally, the company
could make no change and vigorously defend its current accounting method. Ellison
carefully considered which alternative made the most sense for the ¬rm.


QUESTIONS
1. What factors might have led analysts to question Oracle Systems™ method of revenue
recognition in mid-1990? Are these legitimate concerns?
2. Estimate the earnings impact for Oracle from recognizing revenue at delivery, rather
than when a contract is signed.
3. What accounting or communication changes would you recommend to Oracle™s
Board of Directors?
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Revenue Analysis




6-21 Part 2 Business Analysis and Valuation Tools




EXHIBIT 1
Oracle Systems Corporation “ Consolidated Financial Statements

CONSOLIDATED BALANCE SHEETS
As of May 31, 1990 and 1989 (in $000, except per share data)
Oracle Systems Corporation




1990 1989
.....................................................................................................................................

ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 44,848 $ 44,893
Short-term investments 4,980 4,500
Receivables
Trade, net of allowance for doubtful accounts of $28,445 in 1990
and $16,829 in 1989 468,071 261,989
Other 28,899 16,175
Prepaid expenses and supplies 22,459 9,376
Total current assets 569,257 336,933
PROPERTY, net 171,945 94,455
COMPUTER SOFTWARE DEVELOPMENT COSTS, net of accumu-
lated amortization of $14,365 in 1990 and $6,180 in 1989 33,396 13,942
OTHER ASSETS 12,649 14,879
$787,247 $460,209
TOTAL ASSETS
LIABILITIES AND STOCKHOLDERS™ EQUITY
CURRENT LIABILITIES:
Notes payable to banks $ 31,236 $ 9,747
Current maturities of long-term debt 11,265 13,587
Accounts payable 64,922 51,582
Income taxes payable 18,254 14,836
Accrued compensation and related bene¬ts 61,164 39,063
Customer advances and unearned revenues 42,121 15,403
Other accrued liabilities 32,417 23,400
Sales tax payable 22,193 8,608
Deferred income taxes ” 2,107
Total current liabilities 283,572 178,333
LONG-TERM DEBT 89,129 33,506
OTHER LONG-TERM LIABILITIES 4,936 5,702
DEFERRED INCOME TAXES 22,025 12,114
STOCKHOLDERS™ EQUITY:
Common stock, $.01 par value-authorized, 200,000,000 shares;
outstanding: 131,138,302 shares in 1990 and 126,933,288
shares in 1989 388 346
Additional paid-in capital 118,715 84,931
Retained earnings 267,475 150,065
Accumulated foreign currency translation adjustments 1,007 (4,788)
Total stockholders™ equity 387,585 230,554
$787,247 $460,209
TOTAL LIABILITIES AND STOCKHOLDERS™ EQUITY
.....................................................................................................................................
242 Revenue Analysis




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Revenue Analysis




CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended May 31, 1990 to 1988 (in $000, except per share data)

1990 1989 1988
....................................................................................................................................




Oracle Systems Corporation
REVENUES
Licenses $689,898 $417,825 $205,435
Services 280,946 165,848 76,678
Total revenues 970,844 583,673 282,113

OPERATING EXPENSES
Sales and marketing 465,074 272,812 124,148
Cost of services 160,426 100,987 51,241
Research and development 88,291 52,570 25,708
General and administrative 67,258 34,344 17,121
Total operating expenses 781,049 460,713 218,218
OPERATING INCOME 189,795 122,960 63,895
OTHER INCOME (EXPENSE):
Interest income 3,772 2,724 2,472
Interest expense (12,096) (4,318) (1,540)
Other income (expense) (8,811) (1,121) 152
Total other income (expense) (17,135) (2,715) 1,084
INCOME BEFORE PROVISION FOR INCOME
TAXES 172,660 120,245 64,979
PROVISION FOR INCOME TAXES 55,250 38,479 22,093

NET INCOME $117,410 $81,766 $42,886
EARNINGS PER SHARE $ .86 $ .61 $ .32
NUMBER OF COMMON AND COMMON
EQUIVALENT SHARES OUTSTANDING 136,826 135,066 132,950
....................................................................................................................................
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Revenue Analysis




6-23 Part 2 Business Analysis and Valuation Tools




CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended May 31, 1990 to 1988 (in $000)

1990 1989 1988
......................................................................................................................................
Oracle Systems Corporation




CASH FLOWS FROM OPERATING ACTIVITIES
Net income $117,410 $ 81,766 $ 42,886
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 44,078 23,156 12,973
Provision for doubtful accounts 16,625 9,211 4,839
Increase in receivables (227,046) (149,900) (74,777)
Increase in prepaid expenses & supplies (12,834) (5,684) (1,458)
Increase in accounts payable 12,491 25,236 12,854
Increase income taxes payable 3,002 6,821 7,940
Increase in other accrued liabilities 42,166 38,057 21,420
Increase in customer advances
and unearned revenues 25,786 6,496 5,682
Increase (decrease) in deferred taxes 7,728 (10,857) 8,170
Increase (decrease) in other non-current liabilities (766) 1,938 ”
Net cash provided by operating activities 28,640 26,240 40,529

CASH FLOWS FROM INVESTING ACTIVITIES
Increase in short-term investments (480) 2,998 (7,498)
Capital expenditures (89,275) (68,428) (30,959)

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