Microsoft Corporation: Q1 2010 (Ended Sept 30, 2009) 10-Q Summary
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2009 (First Quarter of Fiscal Year 2010). Microsoft Corporation operates as a large accelerated filer, generating revenue through software products, services, and hardware (including Xbox 360). The reporting period was significantly impacted by the deferral of revenue related to the upcoming Windows 7 launch and ongoing global economic conditions.
Key Financial Metrics
| Metric (in millions, except per share) | Q1 2010 | Q1 2009 |
|---|---|---|
| Revenue | $12,920 | $15,061 |
| Operating Income | $4,482 | $5,999 |
| Net Income | $3,574 | $4,373 |
| Diluted EPS | $0.40 | $0.48 |
| Operating Margin | 34.7% | 39.8% |
| Cash from Operations | $6,107 | $3,370 |
| Total Cash & Investments | $36,728 | $31,447 |
| Total Debt (Short + Long Term) | $6,000 | $5,746 |
Material Changes vs. Prior Period
- Revenue Decline: Revenue decreased 14% year-over-year. The primary driver was the deferral of approximately $1.5 billion in revenue related to the "Windows 7 Upgrade Option" and pre-general availability sales of Windows 7 to OEMs and retailers.
- Operating Income: Decreased 25% to $4.48 billion, reflecting lower revenue partially offset by reduced operating expenses across all categories.
- Expense Reductions:
- Sales & Marketing: Down 8% ($254 million) due to headcount reductions and lower marketing spend.
- R&D: Down 10% ($218 million) due to headcount reductions and capitalization of Windows 7 development costs.
- G&A: Down 16% ($146 million) driven by headcount reductions and lower legal expenses.
- Cash Flow: Net cash from operations increased significantly to $6.1 billion (up $2.7 billion), largely due to a $3.1 billion tax payment made in the prior year that did not recur.
- Segment Performance:
- Windows & Windows Live: Revenue down 39% (GAAP) due to the Windows 7 deferral.
- Server and Tools: Revenue flat; Operating income up 23%.
- Microsoft Business Division: Revenue down 11% due to lower Office 2007 licensing activity.
- Entertainment and Devices: Revenue flat; Operating income up 96% due to cost reductions.
Guidance, Outlook, and Risks
- Outlook: Management sees potential for improvement in calendar year 2010 but notes timing is uncertain due to global macroeconomic factors. The company remains focused on expense management and product delivery.
- Windows 7 Impact: The revenue deferral negatively impacted Q1 2010 but is expected to positively impact Q2 2010 upon general availability.
- Capital Allocation:
- Share Repurchases: Repurchased 58 million shares for $1.4 billion. Approximately $33.1 billion remains of the $40 billion program authorized in September 2008.
- Dividends: Declared a quarterly dividend of $0.13 per share.
- Legal & Regulatory Risks:
- European Commission: Ongoing competition law investigations regarding Internet Explorer bundling and Office interoperability. Microsoft offered commitments to resolve concerns regarding browser choice.
- Patent Litigation: Significant ongoing cases include Alcatel-Lucent (damages retrial pending), Uniloc (verdict overturned), and i4i (injunction stayed pending appeal). Total accrued liabilities for contingencies are approximately $1.1 billion, with potential exposure up to $1.9 billion beyond recorded amounts.
- Investment Portfolio: No other-than-temporary impairments recorded in Q1 2010. Unrealized losses on investments were $110 million, primarily due to interest rate changes and market price movements.
Investor Verification Checklist
- Verify the magnitude of the $1.5 billion revenue deferral related to Windows 7 and its expected recognition in Q2 2010.
- Monitor the outcome of the European Commission decision regarding the browser ballot mechanism and Office interoperability.
- Track the status of major patent litigation (Alcatel-Lucent, i4i) and potential changes to the $1.1 billion accrued liability.
- Assess the impact of headcount reductions (approx. 5,000 positions eliminated) on future R&D output and product roadmaps.
- Review the Windows 7 Upgrade Option terms and their effect on future upgrade revenue cycles.