Business Context and Reporting Period
This summary covers the Form 10-Q filed by Microsoft Corporation for the quarterly period ended December 31, 2005 (Fiscal Q2 2006). The company operates globally, developing, manufacturing, licensing, and supporting software products for servers, PCs, and intelligent devices, as well as online services and gaming consoles. The reporting period includes the launch of the Xbox 360 console and significant product releases including SQL Server 2005 and Visual Studio 2005.
Key Financial Metrics
| Metric | Three Months Ended Dec 31, 2005 | Six Months Ended Dec 31, 2005 |
|---|---|---|
| Revenue | $11,837 million | $21,578 million |
| Operating Income | $4,657 million | $8,703 million |
| Net Income | $3,653 million | $6,794 million |
| Diluted EPS | $0.34 | $0.63 |
| Cash from Operations | $2,231 million | $6,560 million |
| Cash and Equivalents | $4,083 million (Balance Sheet) | $4,083 million (Balance Sheet) |
| Short-term Investments | $30,618 million | $30,618 million |
| Total Debt | None reported | None reported |
Liquidity: Total cash and short-term investments stood at $34.70 billion as of December 31, 2005. The company has no material long-term debt.
Material Changes vs. Prior Period
- Revenue Growth: Revenue increased 9% year-over-year for the quarter and 8% for the six-month period, driven by growth in Windows Server, SQL Server, Windows Client OEM licensing, and the Xbox 360 launch.
- Operating Income Decline (Quarterly): Operating income decreased 2% for the quarter ($4,657 million vs. $4,749 million) primarily due to a 27% increase in sales and marketing expenses related to product launches and a $410 million increase in cost of revenue driven by Xbox 360 console costs.
- Operating Income Growth (Six Months): Operating income increased 6% for the six-month period, driven by higher-margin Server and Client revenue and lower legal costs, partially offset by increased marketing and Xbox launch costs.
- Stock Repurchases: The company repurchased approximately 397 million shares for $10.55 billion during the six months ended December 31, 2005, a significant increase from the prior year period.
- Dividends: A regular quarterly dividend of $0.09 per share was declared, payable in March 2006.
Guidance, Outlook, and Risks
- Outlook: Management expects revenue to grow at a faster rate in the remainder of fiscal year 2006 due to significant product launches. Operating income growth is expected to exceed revenue growth due to lower legal settlement costs, though this will be partially offset by launch-related expenses and investments in MSN.
- Market Estimates: Worldwide PC shipments are estimated to grow 12% to 14% in fiscal 2006. Server hardware shipments are estimated to grow 11% to 13%.
- Legal Contingencies:
- European Commission: A Statement of Objections was issued in December 2005 alleging non-compliance with the 2004 decree, potentially resulting in fines up to €2 million per day. Microsoft is disputing this.
- Korean Fair Trade Commission (KFTC): Ruled in December 2005 that Microsoft abused a dominant position, imposing a ~$32 million fine and requiring the distribution of Windows versions without media player/instant messenger functionality in Korea. Microsoft plans to appeal.
- Antitrust Class Actions: Estimated total cost to resolve state-level antitrust settlements ranges between $1.3 billion and $1.5 billion; $1.1 billion has been accrued.
- Unusual Items: The adoption of SFAS No. 123(R) for stock-based compensation did not have a significant impact on financial results. Net losses on derivatives were $185 million for the quarter, primarily due to foreign exchange and equity derivatives.
Investor Verification Checklist
- Xbox 360 Margins: Verify the trajectory of gross margins for the Xbox 360 console, which currently have negative gross margins and are driving increased cost of revenue.
- Legal Exposure: Monitor the status of the European Commission Statement of Objections and the KFTC ruling, as fines or mandated product changes could impact future profitability and product strategy.
- Share Repurchase Execution: Confirm the pace of the remaining $11.3 billion in the $30 billion share repurchase program, which is scheduled to be completed by December 2006.
- Unearned Revenue: Review the $8.8 billion in unearned revenue, noting that $2.88 billion is expected to be recognized in the next quarter (ending March 31, 2006).
- MSN Performance: Assess the impact of the MSN adCenter launch on search advertising revenue per search (RPS), which saw a reduction in the current period.