Business Context and Reporting Period
Company: Microsoft Corporation
Filing Type: Form 10-K (Annual Report)
Period Ended: June 30, 2001
Business Overview: Microsoft develops, manufactures, licenses, and supports software products for servers, PCs, and intelligent devices. Core segments include Desktop and Enterprise Software and Services, Consumer Software, Services, and Devices, Consumer Commerce Investments (including Expedia), and Other. The company is transitioning its strategy toward the Microsoft .NET platform for XML Web services.
Key Financial Metrics (Fiscal Year 2001)
| Metric | Value (in millions) |
|---|---|
| Revenue | $25,296 |
| Operating Income | $11,720 |
| Net Income | $7,346 |
| Diluted EPS | $1.32 |
| Cash and Short-Term Investments | $31,600 |
| Total Assets | $59,257 |
| Stockholders' Equity | $47,289 |
| Operating Cash Flow | $13,422 |
| Long-Term Debt | None (No material long-term debt) |
Margins: Operating margin was approximately 46.3%. Cost of revenue was 13.7% of revenue. Research and Development (R&D) expenses were $4.38 billion (17.3% of revenue).
Material Changes vs. Prior Period
- Revenue Growth: Revenue increased 10% to $25.3 billion, driven by licensing of Windows 2000 Professional, SQL Server, and .NET Enterprise Servers. Growth was slower than the 16% seen in fiscal 2000.
- Profitability Decline: Net income decreased 22% to $7.35 billion from $9.42 billion in fiscal 2000. This decline was primarily due to a $3.92 billion pre-tax impairment of investments (mostly cable and telecommunications) and a $375 million after-tax cumulative effect of an accounting change (SFAS 133).
- Investment Losses: Investment income turned into a net loss of $36 million, a decrease of $3.36 billion from the prior year, largely due to the aforementioned impairments and net losses on derivative instruments ($592 million).
- Segment Performance: Desktop and Enterprise Software revenue grew to $22.41 billion. Consumer Commerce Investments revenue grew to $299 million, though Microsoft announced an agreement to sell its controlling interest in Expedia to USA Networks.
Guidance, Outlook, and Risks
Management Commentary & Outlook:
- Management anticipates revenue growth in 2002 may not match prior years due to fixed operating expenses and potential market saturation.
- Significant investments are planned for Microsoft .NET, "HailStorm" (user-centric services), Xbox (scheduled for release in late 2001), and wireless technologies.
- Cost of revenue as a percentage of revenue may increase in 2002 due to the introduction of the Xbox hardware.
Risks and Contingencies:
- Antitrust Litigation: The U.S. Court of Appeals vacated the judgment ordering Microsoft's breakup but affirmed violations of Section 2 of the Sherman Act. The case was remanded for a new trial on one claim and entry of a new judgment. Plaintiffs have indicated they will seek conduct remedies rather than a breakup. Microsoft is also facing numerous class-action lawsuits alleging monopolization.
- European Commission: Proceedings allege failure to disclose interoperability information and discriminatory licensing. Remedies sought include mandatory technology disclosure and fines.
- Competition: Intense competition from open-source software (Linux), new computing form factors, and collaborative efforts by competitors (IBM, Sun, Oracle, AOL Time Warner) to move applications to server-based models.
- Accounting Changes: Adoption of SFAS 133 (Derivatives) and upcoming adoption of SFAS 142 (Goodwill) which will stop goodwill amortization but require annual impairment testing.
Investor Verification Checklist
- Investment Impairments: Verify the composition and recoverability of the $4.80 billion in investment impairments, specifically regarding cable and telecommunications holdings.
- Antitrust Resolution: Monitor the outcome of the remanded antitrust trial and the potential for conduct remedies that could alter business practices or licensing models.
- Expedia Transaction: Confirm the closing of the USA Networks acquisition of Expedia and the final valuation of Microsoft's remaining interest.
- Xbox Launch: Assess the initial market reception and cost structure of the Xbox console, which is expected to impact cost of revenue margins.
- Revenue Recognition: Review the impact of ratable revenue recognition on future earnings stability, particularly as subscription and maintenance programs grow.