Microsoft Corporation 10-Q Summary: Quarter Ended December 31, 2008
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended December 31, 2008 (Fiscal Year 2009, Q2). Microsoft Corporation is a large accelerated filer incorporated in Washington. The company develops, manufactures, licenses, and supports software products, services, and hardware, including the Windows operating system, Microsoft Office, Xbox 360, and online services. The filing reflects operations during a period of significant global economic deterioration.
Key Financial Metrics
| Metric | Three Months Ended Dec 31, 2008 | Six Months Ended Dec 31, 2008 |
|---|---|---|
| Revenue | $16,629 million | $31,690 million |
| Operating Income | $5,939 million | $11,938 million |
| Net Income | $4,174 million | $8,547 million |
| Diluted EPS | $0.47 | $0.94 |
| Cash from Operations | $5,782 million | $9,152 million |
| Cash & Short-Term Investments | $20,715 million (as of Dec 31, 2008) | |
| Short-Term Debt | $2,000 million (Commercial Paper) | |
| Effective Tax Rate | 26% | 27% |
Material Changes vs. Prior Period
- Revenue: Increased 2% year-over-year for the quarter and 5% for the six-month period. Growth was driven by SQL Server, Windows Server, and Xbox 360, offset by weakness in the PC market and a shift to lower-priced netbooks.
- Operating Income: Decreased 8% for the quarter and 3% for the six-month period. Declines were primarily due to increased headcount-related expenses (up 12% for the quarter) and higher cost of revenue, particularly in online services and Xbox 360.
- Other Income (Expense): Turned negative, reporting a loss of $301 million for the quarter compared to income of $367 million in the prior year. This was driven by net losses on derivatives ($409 million) and foreign currency remeasurements ($350 million).
- Investment Impairments: Other-than-temporary impairments on investments increased significantly to $262 million for the quarter (vs. $54 million prior year) due to declining equity markets.
- Share Repurchases: The company repurchased 94 million shares for $2.2 billion in the quarter and 318 million shares for $8.2 billion in the six-month period.
Outlook, Management Commentary, and Risks
- Resource Management Program: On January 22, 2009, management announced a program to reduce operating expenses, headcount, and capital expenditures. This includes eliminating up to 5,000 jobs (1,400 immediately) and reducing the annual operating expense run rate by approximately $1.5 billion. Costs will be recognized in Q3 FY2009.
- Economic Outlook: Management expects economic conditions to further deteriorate for the remainder of fiscal year 2009. The company is focusing on high-value products and expense management.
- Legal Contingencies:
- European Commission: A statement of objections was issued on January 15, 2009, regarding the inclusion of Internet Explorer in Windows, potentially seeking a significant fine and remedies requiring OEMs to offer browser choices.
- Alcatel-Lucent: A settlement was reached in December 2008 resolving most patent disputes, though approximately $500 million remains in dispute regarding one patent.
- Class Actions: Estimated total cost to resolve overcharge class actions ranges between $1.7 billion and $1.9 billion; $900 million is currently accrued.
- Tax Settlement: The company paid approximately $3.1 billion to the IRS in Q1 FY2009 to settle a 2000-2003 examination.
Investor Verification Checklist
- Expense Reduction Impact: Verify the timing and magnitude of the $1.5 billion annual expense reduction and the specific severance costs to be recognized in Q3 FY2009.
- European Commission Fine: Monitor the outcome of the January 2009 statement of objections regarding Internet Explorer, as the potential fine amount is not currently estimable.
- Investment Portfolio Health: Assess the risk of further other-than-temporary impairment charges given the volatility in equity markets and the $262 million impairment already recorded in Q2.
- PC Market Trends: Evaluate the continued shift to netbooks and its impact on the "OEM premium mix" and Client segment revenue margins.
- Debt Covenants: Confirm continued compliance with the credit facility covenant requiring a coverage ratio of at least three times EBITDA to interest expense.