Business Context and Reporting Period
Company: Microsoft Corporation
Filing Type: Form 10-K (Annual Report)
Reporting Period: Fiscal Year ended June 30, 2011
Business Overview: Microsoft develops, licenses, and supports software, services, and hardware. Key segments include Windows & Windows Live, Server and Tools, Online Services, Microsoft Business Division, and Entertainment and Devices. The company operates in over 100 countries and employs approximately 90,000 people.
Key Financial Metrics
| Metric | Fiscal 2011 | Fiscal 2010 |
|---|---|---|
| Revenue | $69.9 billion | $62.5 billion |
| Operating Income | $27.2 billion | $24.1 billion |
| Net Income | $23.2 billion | $18.8 billion |
| Diluted EPS | $2.69 | $2.10 |
| Operating Margin | 38.8% | 38.6% |
| Cash & Short-term Investments | $52.8 billion | $36.8 billion |
| Long-term Debt | $11.9 billion | $4.9 billion |
| Free Cash Flow (Operating) | $27.0 billion | $24.1 billion |
Material Changes vs. Prior Period
- Revenue Growth: Revenue increased 12% year-over-year, driven by strong sales of the Xbox 360 platform, the 2010 Microsoft Office system, and Server and Tools products. This growth was partially offset by lower Windows revenue.
- Segment Performance:
- Entertainment and Devices: Revenue surged 45% to $8.9 billion, led by Xbox 360 console volumes and Kinect sensor sales.
- Microsoft Business Division: Revenue grew 16% to $22.2 billion, driven by Office 2010 sales and the recognition of previously deferred revenue.
- Windows & Windows Live: Revenue declined 2% to $19.0 billion, reflecting a slowdown in the PC market and lower recognition of deferred Windows XP revenue.
- Online Services: Revenue increased 15% to $2.5 billion, though the segment reported an operating loss of $2.6 billion due to high traffic acquisition costs and Yahoo! agreement expenses.
- Debt Issuance: Long-term debt increased significantly from $4.9 billion to $11.9 billion as the company issued new debt to fund share repurchases and acquisitions.
- Tax Rate: The effective tax rate dropped to 17.5% from 25.0%, primarily due to a higher mix of foreign earnings taxed at lower rates and a $461 million benefit from a partial IRS settlement.
Guidance, Outlook, and Risks
Strategic Outlook: Management emphasizes a transition to a "cloud-based computing model" and smart connected devices. Key investment areas include cloud infrastructure (Windows Azure, Office 365), search (Bing), and mobile platforms (Windows Phone).
Material Events:
- Skype Acquisition: On May 10, 2011, Microsoft announced a definitive agreement to acquire Skype for $8.5 billion in cash, subject to regulatory approval.
- Nokia Alliance: A strategic alliance was formed with Nokia to make Windows Phone Nokia's primary smartphone platform.
Risks and Contingencies:
- Cloud Execution: Significant risks exist regarding the execution of the cloud strategy, including infrastructure costs and competition from Amazon and Google.
- Legal Proceedings: Ongoing antitrust and patent litigation (e.g., Novell, i4i, Motorola) could result in significant damages or injunctions.
- Intellectual Property: Risks related to software piracy and third-party infringement claims remain material.
- IRS Audit: While a partial settlement was reached for tax years 2004-2006, the IRS issued a Revenue Agent's Report for remaining items which Microsoft has protested; the outcome remains uncertain.
Investor Verification Checklist
- Skype Closing: Verify the status of regulatory approvals for the $8.5 billion Skype acquisition.
- Windows Phone Adoption: Monitor market share data for Windows Phone following the Nokia alliance to assess mobile strategy success.
- Cloud Margins: Track the profitability trajectory of the Online Services Division and cloud offerings (Azure, Office 365) as infrastructure costs are high.
- IRS Dispute: Monitor the administrative appeals process regarding the IRS Revenue Agent's Report for tax years 2004-2006.
- Debt Servicing: Review the impact of the increased long-term debt load ($11.9 billion) on future interest expenses and cash flow.