Business Context and Reporting Period
Company: Microsoft Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: December 31, 2011 (Second Quarter of Fiscal Year 2012)
Business Overview: Microsoft develops, licenses, and supports software products and services, designs and sells hardware, and delivers online advertising. Key segments include Windows & Windows Live, Server and Tools, Online Services, Microsoft Business Division, and Entertainment and Devices.
Key Financial Metrics
| Metric (in millions) | Three Months Ended Dec 31, 2011 | Six Months Ended Dec 31, 2011 |
|---|---|---|
| Revenue | $20,885 | $38,257 |
| Operating Income | $7,994 | $15,197 |
| Net Income | $6,624 | $12,362 |
| Diluted EPS | $0.78 | $1.46 |
| Operating Margin | 38.3% | 39.7% |
| Cash from Operations | $5,862 | $14,355 |
| Cash & Short-term Investments | $51,736 (Balance Sheet) | $51,736 (Balance Sheet) |
| Long-term Debt | $11,932 | $11,932 |
Material Changes vs. Prior Period
- Revenue Growth: Revenue increased 5% year-over-year for the quarter and 6% for the six-month period. Growth was driven by Server and Tools, Xbox 360, and Office 2010 sales, partially offset by a decline in PC sales to consumers.
- Operating Income: Operating income decreased 2% for the quarter and 1% for the six-month period due to higher operating expenses, despite revenue growth.
- Expense Increases:
- Cost of Revenue: Increased 17% (quarter) and 18% (six months) due to higher Xbox volumes, royalty costs, online traffic acquisition costs, and payments to Nokia.
- R&D: Increased 9% (quarter) and 7% (six months) primarily due to higher headcount-related expenses.
- G&A: Increased 19% (quarter) and 21% (six months) driven by Puerto Rican excise taxes, headcount costs, and legal fees.
- Acquisition Impact: The $8.6 billion acquisition of Skype (closed Oct 13, 2011) contributed to revenue and operating expenses in the Entertainment and Devices Division. Goodwill increased by approximately $7.1 billion.
- Foreign Currency: Favorable foreign currency impacts of $225 million (quarter) and $635 million (six months) contributed to revenue.
Guidance, Outlook, and Risks
- Management Commentary: Management highlighted strong sales in Server and Tools and the Xbox 360 platform. The Online Services Division (OSD) operating loss narrowed due to revenue growth and lower sales/marketing expenses. Bing's U.S. market share grew to approximately 15%.
- Capital Allocation:
- Share Repurchases: Repurchased 39 million shares ($1.0 billion) in the quarter and 78 million shares ($2.0 billion) in the six months. Approximately $10.2 billion remains of the $40.0 billion program.
- Dividends: Declared dividends of $0.20 per share for the quarter (up from $0.16 in the prior year).
- Risks and Contingencies:
- Legal: Significant ongoing litigation includes antitrust class actions (estimated total cost $1.9–$2.0 billion), patent disputes (e.g., Alcatel-Lucent, Uniloc, Motorola), and IRS audits regarding transfer pricing.
- Tax: Effective tax rate was approximately 20% for the quarter, lower than the statutory rate due to foreign earnings. Tax contingencies totaled $7.7 billion.
- Market Risk: Exposure to foreign currency, interest rates, and equity prices. One-day Value-at-Risk (VaR) was $298 million as of Dec 31, 2011.
Investor Verification Checklist
- Skype Integration: Verify the progress of integrating Skype into Microsoft's product portfolio and the associated amortization of intangible assets.
- PC Market Trends: Monitor the correlation between global PC shipment declines and the Windows & Windows Live Division's revenue performance.
- Legal Reserves: Review the status of the IRS audit appeal and the final resolution of the Alcatel-Lucent and Uniloc patent cases to assess potential liability adjustments.
- Cloud Economics: Assess the margin impact of continued heavy investment in cloud infrastructure (Windows Azure, Office 365) versus revenue generation.
- Debt Structure: Note the $1.25 billion convertible debt due in 2013 and its potential dilution impact if conversion conditions are met.