MSFT

Microsoft Corporation 10-Q Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2009 (Fiscal Year 2009, Q3). Microsoft Corporation is a large accelerated filer incorporated in Washington. The company develops, manufactures, licenses, and supports software products, services, and hardware, including the Windows operating system, Microsoft Office, Xbox 360, and online services.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue: Declined 6% year-over-year for the quarter to $13.6 billion, driven by weakness in the global PC market and a shift to lower-priced netbooks. For the nine-month period, revenue increased 2% to $45.3 billion.
• Operating Income: Increased 3% for the quarter to $4.4 billion, primarily due to a significant reduction in General and Administrative (G&A) expenses ($1.4 billion decrease) related to legal settlements. This offset lower revenue and a $290 million employee severance charge.
• Net Income: Decreased 32% for the quarter to $3.0 billion. The decline was driven by lower "Other income (expense)" due to investment impairments and a higher tax provision compared to the prior year, which benefited from a one-time tax settlement resolution.
• Investment Impairments: Other-than-temporary impairments on investments totaled $420 million for the quarter and $754 million for the nine months, reflecting deteriorating equity markets.
• Segment Performance:
  • Client: Revenue down 16% (quarter) due to PC market weakness.
  • Server and Tools: Revenue up 7% (quarter) driven by SQL Server and Windows Server growth.
  • Online Services: Operating loss widened to $575 million (quarter) due to increased traffic acquisition costs.
  • Entertainment and Devices: Operating income turned to a loss of $31 million (quarter) due to increased R&D and cost of revenue.

Guidance, Outlook, and Risks

• Outlook: Management expects trends seen in the third quarter to continue into the fourth quarter, including weakness in PC and server hardware markets and non-annuity businesses.
• Cost Management: In January 2009, Microsoft announced a resource management program to eliminate up to 5,000 positions by June 30, 2010. Approximately 1,100 employees were reduced in the quarter, with a $290 million charge recorded. The company also plans to eliminate merit increases for fiscal year 2010.
• Legal Contingencies:
  • European Commission: A statement of objections was issued regarding the inclusion of Internet Explorer in Windows, potentially seeking a remedy requiring OEMs to offer browser choice and imposing a significant fine. The outcome is not reasonably estimable.
  • Patent Litigation: A $388 million verdict was returned against Microsoft in the UnilocUSA patent infringement case; the company plans to appeal. A settlement with Alcatel-Lucent resolved most claims, though approximately $500 million remains in dispute regarding one patent.
  • Class Actions: Estimated total cost to resolve overcharge class action cases is between $1.8 billion and $2.0 billion.
• Share Repurchases: No shares were repurchased in the quarter. Approximately $34.5 billion remains available under the current $40 billion authorization program.

Investor Verification Checklist

• Verify the impact of the $290 million employee severance charge on future operating expenses and headcount reduction targets.
• Monitor the status of the European Commission investigation regarding Internet Explorer and potential fines.
• Assess the trajectory of investment portfolio impairments given the continued volatility in equity markets.
• Review the "Other income (expense)" line item for continued losses on derivatives and foreign currency remeasurements.
• Confirm the execution of the resource management program and its effect on R&D and sales productivity.