Microsoft Corporation 10-Q Summary
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended March 31, 1997 (Fiscal Q3 1997) and the nine months ended March 31, 1997. Microsoft Corporation develops, manufactures, and licenses software products including operating systems (Windows 95, Windows NT), productivity applications (Microsoft Office 97), and online services (MSN). The company recently terminated a partnership with TCI to become the sole owner of MSN and announced an agreement to acquire WebTV Networks, Inc.
Key Financial Metrics
| Metric (in millions) | Q3 1997 | Q3 1996 | 9 Months 1997 | 9 Months 1996 |
|---|---|---|---|---|
| Net Revenues | $3,208 | $2,205 | $8,183 | $6,416 |
| Operating Income | $1,568 | $774 | $3,551 | $2,268 |
| Net Income | $1,042 | $562 | $2,397 | $1,636 |
| Diluted EPS | $0.79 | $0.44 | $1.83 | $1.28 |
| Cash & Short-term Investments | $9,086 | $6,940 | $9,086 | $6,770 |
| Operating Cash Flow (9mo) | $3,619 (vs $2,806 prior year) | |||
| Stock Repurchases (9mo) | $2,975 (vs $800 prior year) |
Margins (Q3 1997): Operating margin was 48.9% (up from 35.1% in Q3 1996). Net income margin was 32.5% (up from 25.5%). Cost of revenues decreased to 9.3% of revenue.
Material Changes vs. Prior Period
- Revenue Growth: Q3 revenues increased 45% year-over-year, driven by the introduction of Microsoft Office 97 and strong OEM licensing of Windows 95 (preinstalled on >75% of new PCs).
- Profitability: Net income more than doubled to $1.04 billion. Improvements were driven by lower cost of revenues (shift to CD-ROM and corporate licensing) and reduced sales/marketing expense as a percentage of revenue.
- Balance Sheet: Cash and short-term investments grew to $9.09 billion. Unearned revenues increased significantly to $1.29 billion due to new revenue recognition policies for Windows and Office 97 (recognizing revenue ratably over product life cycles).
- Capital Allocation: The company repurchased $2.98 billion of common stock in the first nine months of fiscal 1997, compared to $800 million in the prior year period. Proceeds from $980 million in convertible preferred stock issuance were used to fund these buybacks.
Guidance, Outlook, and Risks
- Acquisition: Microsoft agreed to acquire WebTV Networks for $425 million. An in-process R&D write-off of approximately $300 million is expected in the quarter of acquisition.
- Revenue Recognition: The company extended ratable revenue recognition to Office 97 licenses over an estimated 18-month life cycle, impacting the timing of revenue recognition.
- Legal Proceedings: The U.S. Department of Justice Antitrust Division is conducting an ongoing investigation. Management believes resolution will not have a material adverse impact.
- Outlook: Management expects cash from operations to fund R&D, facility expansion, and strategic acquisitions. The company plans to continue stock repurchases to offset dilution from employee stock options.
Investor Verification Checklist
- Verify the impact of the new revenue recognition policy on future quarters for Windows and Office 97.
- Monitor the closing of the WebTV acquisition and the timing of the $300 million R&D write-off.
- Assess the sustainability of the 45% revenue growth rate given the shift from retail upgrades to OEM licensing.
- Review the status of the DOJ antitrust investigation for potential regulatory risks.
- Confirm the effectiveness of the stock repurchase program in offsetting dilution from employee stock options.