Business Context and Reporting Period
This Form 10-K covers Microsoft Corporation for the fiscal year ended June 30, 2003. Microsoft develops, manufactures, licenses, and supports software products for servers, PCs, and intelligent devices, including the Windows operating system, Office productivity suite, and the Xbox video game console. The company operates through seven segments: Client, Server and Tools, Information Worker, Microsoft Business Solutions, MSN, Mobile and Embedded Devices, and Home and Entertainment. As of June 30, 2003, the company employed approximately 55,000 people globally.
Key Financial Metrics
| Metric (in millions) | Fiscal 2003 | Fiscal 2002 |
|---|---|---|
| Revenue | $32,187 | $28,365 |
| Operating Income | $13,217 | $11,910 |
| Net Income | $9,993 | $7,829 |
| Diluted EPS | $0.92 | $0.70 |
| Operating Margin | 41.1% | 42.0% |
| Cash and Short-Term Investments | $49,048 | $38,652 |
| Operating Cash Flow | $15,797 | $14,509 |
| Total Assets | $79,571 | $67,646 |
| Stockholders' Equity | $61,020 | $52,180 |
Debt and Liquidity: Microsoft reported no material long-term debt. The company maintained a strong liquidity position with $49.0 billion in cash and short-term investments. Unearned revenue totaled $9.0 billion, reflecting significant multi-year licensing agreements.
Material Changes vs. Prior Period
- Revenue Growth: Revenue increased 13% to $32.2 billion, driven by multi-year licensing arrangements prior to the transition to Licensing 6.0, a $933 million increase in OEM licensing for Windows, and a $309 million increase in Xbox revenue.
- Profitability: Operating income grew 11% to $13.2 billion. Net income rose 28% to $10.0 billion. This growth was partially offset by a $2.5 billion increase in operating expenses, primarily due to headcount additions and legal settlement costs.
- Investment Income: Investment income turned positive at $1.6 billion (compared to a $305 million loss in 2002), driven by a significant reduction in other-than-temporary impairments ($1.1 billion in 2003 vs. $4.3 billion in 2002) and net gains on sales of investments.
- Segment Performance:
- Client: Revenue grew 11% to $10.4 billion; Operating income grew 11% to $8.4 billion.
- Server and Tools: Revenue grew 16% to $7.1 billion; Operating income grew 20% to $2.5 billion.
- Information Worker: Revenue grew 12% to $9.2 billion; Operating income grew 9% to $7.0 billion.
- Home and Entertainment: Revenue grew 12% to $2.7 billion, but operating loss widened to $924 million due to Xbox product costs and marketing expenses.
- MSN: Revenue grew 24% to $2.0 billion; Operating loss narrowed significantly to $299 million.
Guidance, Outlook, Risks, and Unusual Items
- Unusual Items: General and administrative expenses included a $750 million charge for a settlement with AOL/Time Warner and a $256 million charge for state antitrust and consumer class action lawsuits. Additionally, a $126 million tax benefit was recorded due to a favorable court ruling on extraterritorial income.
- Acquisitions: The company acquired Navision a/s ($1.465 billion), Rare, Ltd. ($377 million), and Placeware, Inc. ($202 million) during the fiscal year, adding $1.7 billion to goodwill.
- Compensation Changes: In July 2003, Microsoft announced a shift from stock options to Stock Awards for employees and planned to adopt fair value recognition for stock-based compensation (SFAS 123) effective July 1, 2003.
- Risks and Uncertainties:
- Legal: Ongoing antitrust litigation in the U.S. and Europe, including potential fines up to 10% of worldwide revenue from the European Commission. Patent infringement cases (e.g., Eolas Technologies) remain pending.
- Competition: Intense competition from Open Source software (Linux) and traditional rivals in operating systems, servers, and productivity applications.
- Product Cycles: Revenue is sensitive to the timing of new product releases, specifically the upcoming Windows "Longhorn" operating system.
Investor Verification Checklist
- Legal Settlements: Verify the final status and total cost of the AOL/Time Warner settlement and state antitrust class actions.
- Stock-Based Compensation: Review the impact of the upcoming adoption of SFAS 123 on future reported earnings and pro forma adjustments.
- Xbox Margins: Monitor the Home and Entertainment segment for improvements in Xbox hardware margins and the impact of price reductions.
- Investment Portfolio: Assess the stability of the $49 billion cash and short-term investment portfolio and potential future impairment charges.
- Unearned Revenue: Track the recognition of the $9.0 billion unearned revenue balance to gauge future revenue visibility.