Microsoft Corporation 10-Q Summary
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended December 31, 2001 (Fiscal Year 2002, Q2) and the six months ended December 31, 2001. Microsoft Corporation develops, manufactures, and licenses software products, including operating systems, productivity applications, and server tools. Key business developments during the period included the November 15, 2001 launch of the Xbox video game system and the widespread adoption of Windows XP.
Key Financial Metrics
| Metric | Q2 2001 (3 Months) | Q2 2000 (3 Months) | YTD 2001 (6 Months) | YTD 2000 (6 Months) |
|---|---|---|---|---|
| Revenue | $7,741 million | $6,550 million | $13,867 million | $12,316 million |
| Operating Income | $2,841 million | $3,194 million | $5,738 million | $5,971 million |
| Net Income | $2,283 million | $2,624 million | $3,566 million | $4,830 million |
| Diluted EPS | $0.41 | $0.47 | $0.64 | $0.87 |
| Cash & Short-Term Investments | $38,229 million (Dec 31, 2001) | $31,600 million (Jun 30, 2001) | N/A | |
| Operating Cash Flow (6 Months) | N/A | $6,954 million | $5,879 million |
Margins: Operating margin for the quarter was approximately 36.7% ($2,841/$7,741), down from 48.8% in the prior year quarter. Net income margin was 29.5% for the quarter.
Debt & Liquidity: The company reported no material long-term debt. Total stockholders' equity increased to $51.55 billion as of December 31, 2001.
Material Changes vs. Prior Period
- Revenue Growth: Revenue increased 18% year-over-year for the quarter and 13% for the six-month period. Growth was driven by the launch of Xbox and licensing of Windows XP.
- Profitability Decline: Net income decreased 13% for the quarter and 26% for the six-month period compared to the prior year. This was primarily due to a $660 million charge recorded in General and Administrative expenses for a contingent liability related to overcharge class action lawsuits.
- Investment Losses: Investment income turned into a loss of $427 million for the six months ended Dec 31, 2001, compared to income of $1.88 billion in the prior year. This was driven by a $1.95 billion write-down for other-than-temporary impairments on European cable and telecommunications holdings.
- Expense Increases: Cost of revenue increased significantly (from 13.2% to 19.9% of revenue) largely due to the hardware costs associated with the new Xbox console. General and administrative expenses surged due to the litigation charge.
Guidance, Outlook, and Risks
- Outlook: Management expects continued revenue growth from Windows XP and Xbox, though PC shipment contraction and foreign exchange rates (specifically the weaker Japanese yen) pose headwinds. The effective tax rate for fiscal 2002 is estimated at 32%.
- Legal Contingencies:
- Antitrust: The U.S. Department of Justice and nine states reached a settlement regarding the antitrust case; nine states and D.C. continue to litigate remedies. The European Commission is pursuing proceedings regarding interoperability and licensing.
- Class Actions: A proposed settlement for overcharge class action lawsuits was rejected by the court. Microsoft has recorded a $660 million liability for these cases.
- SEC Investigation: The SEC is conducting a non-public investigation into the company's accounting reserve practices.
- Accounting Changes: The company adopted SFAS 141 and SFAS 142, eliminating goodwill amortization. This change increased reported net income by approximately $118 million for the six-month period compared to prior year reporting standards.
- Market Risk: The company faces foreign currency, interest rate, and securities price risks. Value-at-risk models estimate potential 20-day losses of up to $430 million for interest-sensitive investments and $339 million for equity securities.
Key Facts for Investor Verification
- Impact of Litigation Charge: Verify the sustainability of earnings by excluding the one-time $660 million legal charge from General and Administrative expenses.
- Investment Portfolio Health: Assess the remaining exposure to European cable and telecommunications holdings, which caused a $1.95 billion impairment loss in the first half of the year.
- Xbox Economics: Monitor the margin impact of the Xbox hardware launch, which significantly increased Cost of Revenue as a percentage of total revenue.
- Antitrust Resolution: Track the status of the non-settling states in the U.S. antitrust case and the European Commission proceedings, as remedies could impose operational restrictions.
- Share Repurchases: Note the reduction in share repurchases ($1.27 billion in the first six months of 2002 vs. $3.23 billion in the prior year), indicating a shift in capital allocation strategy.