CASE 7.2 Oracle Corporation: Share-Based Compensation Effects/Statement of Shareholders' Equity LO A sales-based ranking of software companies provided by Yahoo! Finance on November 5, 2008, places Oracle Corporation third behind sales leaders Microsoft Corporation and IBM Software. Typical of high-tech companies in the software industry, Oracle Corporation uses share-based compensation plans extensively to motivate its employees." Note e of n part. wa May 31, 2008, annual report, Oracle states that it settles employee stock option exercises primarily with newly issued common shares. As indicated by the selected data from Oracle's May 31, 2008, consolidated balance sheet in Exhibit 7.20, Oracle finances operations using substantially more common shareholder's equity than it does long-term debt. However, Oracle's long-term debt to shareholders' equity ratio of 44.5% is substantially larger than that of major US. competitor Microsoft Corporation and major for- eign competitor SAP AG, both of which report almost no long-term financial debt. Exhibit 7.21 presents the consolidated statement of shareholders' equity for 2008. Exhibit 7.22 presents portions of financial statement Notes 10 and 11. REQUIRED a. Compute Oracle's long-term debt to shareholders' equity ratio for May 31, 2008 and 2007. Identify the increases in shareholders' equity in 2008 from share-based compensa- tion plans. Calculate the long-term debt to shareholders' equity ratio that would have occurred had Oracle not implemented the stock repurchase plan. Comment on the potential effect on future ROE of Oracle's financing strategy. b. Retained earnings increase because of net income and decrease because of dividends declared. Why, then, did Oracle decrease retained earnings when it repurchased common stock? c. Of the first five changes listed in the shareholders' equity section, one of them, the com- mon stock repurchase, clearly represents a cash outflow. Identify the cash flow effects of the other four items. Where will each cash flow effect be reported in the statement of cash flows? d. Oracle engages in many transactions with nonowners (that is, customers, suppliers, and the government) that increase net assets. For example, Oracle's foreign subsidiaries per- form services on credit with unrelated third-party customers. The accounts receivable generated by the transactions are denominated in a foreign currency and thus are reported on the foreign subsidiaries' balance sheet in that foreign currency. The consoli- dation process causes the subsidiary's accounts receivable to be added to the parent company's (Oracle's) accounts receivable and reported on Oracle's Consolidated Balance Sheet. Assuming that the foreign currency strengthens relative to the U.S. dollar, how does Oracle's Consolidated Statement of Shareholders' Equity capture the increases in accounts receivable described in this example transaction? Exhibit 7.20 Oracle Corporation May 31, 2008, Consolidated Balance Sheet (in millions of dollars) (Case 7.2) May 31, 2008 2007 $10,235 $ 6,235 Non-current notes payable and other non-current borrowings Stockholders' equity Common stock, $0.01 par value and additional paid-in capital- authorized: 11,000 shares; outstanding: 5,150 shares and 5,107 shares as of May 31, 2008 and 2007 Retained earnings $12,446 9,961 $10,293 6,223 Accumulated other comprehensive incomes Reserved. May not be copied, scanned, or duplicat 618 whole or in part. WCN 02-2403 $23,025 $16,919 Total stockholders' equity Source: Oracle Corporation, Form 10-K for the Fiscal Year Ended May 31, 2008. Exhibit 7.21 Oracle Corporation Consolidated Statements of Stockholders' Equity at May 31, 2008 (in millions of dollars) (Case 7.2) Common Stock Balances as of May 31, 2007 Common stock issued under stock award plans Common stock issued under stock purchase plans Assumption of stock award in conjunction with acquisitions Stock-based compensation Repurchase of common stock Tax benefits from stock plans Adjustment to retained i eamings upon adoption of FIN 48 Net unrealized loss on and Additional Paid-in Capital Accumulated Number Other Comprehensive of Income Retained Comprehensive Shares Amount Earnings Income Total 5,107 $10,293 $ 6,223 $403 $16,919 137 1,229 1,229 defined benefit plan assets, net of tax Net unrealized losses on Foreign currency translation I derivative financial instruments, net of tax Net unrealized gain on marketable securities, net of tax $ (9) 300 (77) 1 Net income 5,521 Comprehensive income $5,736 Balances as of May 31, 2008 3 59 56 59 240 240 367 367 12 (97) (214) (1,786) (2,000) 472 472 5,150 3 (9) (9) 300 300 (77) (77) 1 5,521 5,521 $12,446 $ 9,961 $618 $23,025 Sources Oracle Corporation; Form 10-K for the Fiscal Year Endod May-33,000, or duplicate, in whs or in part WCN 02-200-200 10. Stockholders' Equity (partial) Stock Repurchases Exhibit 7.22 Oracle Corporation Portions of Notes 10 and 11 (Case 7.2) Our Board of Directors has approved a program for Oracle to repurchase shares of our common stock to reduce the dilutive effect of our stock option and stock purchase plans. In April 2007, our Board of Directors expanded our repurchase program by $4.0 billion and as of May 31, 2008, $2.2 billion was available for share repurchases pursuant to our stock repurchase program. We repurchased 97.3 million shares for $2.0 billion (including 1.1 million shares for $24 million that were repurchased but not settled), 233.5 million shares for $4.0 billion and 146.9 million shares for $2.1 billion in fiscal 2008, 2007 and 2006, respectively. Our stock repurchase authorization does not have an expiration date and the pace of our repurchase activ- ity will depend on factors such as our working capital needs, our cash requirements for acquisitions, our debt repayment obligations (as described above), our stock price, and economic and market conditions. Our stock repurchases may be affected 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. 11. Employee Benefit Plans (partial) Stock-based Compensation Plans Stock Option Plans In connection with certain of our acquisitions, including PeopleSoft, BEA, Siebel and Hyperion, we assumed all of the outstanding stock options and other stock awards of each acquiree's respective stock plans. These stock options and other stock awards generally retain all of the rights, terms and conditions of the respective plans under which they were originally granted. As of May 31, 2008, options to purchase 77 million shares of common stock and 1 million shares of restricted stock were outstanding under these plans. Tax Benefits from Option Exercises We settle employee stock option exercises primarily with newly issued common shares and may, on occa- sion, settle employee stock option exercises with our treasury shares. Total cash received as a result of option exercises was approximately $1.2 billion, $873 million and $573 million for fiscal 2008, 2007 and 2006, respectively. The aggregate intrinsic value of options exercised was $2.0 billion, $986 million and $594 million for fiscal 2008, 2007 and 2006, respectively. In connection with these exercises, the tax benefits real- ized by us were $588 million, $338 million and $169 million for fiscal 2008, 2007 and 2006, respectively. The adoption of Statement 123(R) required us to change our cash flow classification of certain tax benefits received from stock option exercises beginning in fiscal 2007. Of the total tax benefits received, we classified excess tax benefits from stock-based compensation of $454 million and $259 million as cash flows from financing activities rather than cash flows from operating activities for fiscal 2008 and 2007, respectively. Employee Stock Purchase Plan We have an Employee Stock Purchase Plan (Purchase Plan). Starting with the April 1, 2005 semi-annual option period, we amended the Purchase Plan such that employees can purchase shares of common stock at a price per share that is 95% of the fair value of Oracle stock as of the end of the semi-annual option period. As of May 31, 2008, 81 million shares were reserved for future issuances under the Purchase Plan. During fiscal 2008, 2007 and 2006, we issued 3 million, 3 million and 6 million shares, respectively, under the Purchase Plan. Source: Oracle Corporation, Form 10-K for the Fiscal Year Ended May 31, 2008. Read and complete case study 7.2, "Oracle Corporation" in your text. Address the following elements, which are also required elements at the end of the case study: Comment on the difference between net cash provided by operating activities and net income. Speculate on which number is likely to be the better indicator of long-term profitability. .Provide explanations for items "A" through "D" of the case. . Do any of these firms appear to have a cash flow problem?