Business Context and Reporting Period
This Form 10-Q covers Microsoft Corporation for the quarterly period ended March 31, 1996 (Fiscal Q3 1996) and the nine months ended March 31, 1996. Microsoft develops, manufactures, and licenses software products including operating systems (Windows 95, Windows NT), server applications, and productivity programs (Microsoft Office). The company distributes products via OEM licenses, corporate licensing, and retail channels.
Key Financial Metrics
| Metric | Q3 1996 | Q3 1995 | 9 Months 1996 | 9 Months 1995 |
|---|---|---|---|---|
| Net Revenues | $2,205M | $1,587M | $6,416M | $4,316M |
| Operating Income | $774M | $549M | $2,268M | $1,506M |
| Net Income | $562M | $396M | $1,636M | $1,085M |
| Earnings Per Share | $0.88 | $0.63 | $2.56 | $1.74 |
| Cash & Short-Term Investments | $6,770M (as of Mar 31, 1996) | |||
| Net Cash from Operations | $2,806M (9 months 1996) | |||
| Stockholders' Equity | $6,595M (as of Mar 31, 1996) |
Margins (Q3 1996): Operating margin was 35.1%; Net income margin was 25.5%. Cost of revenues was 13.4% of revenue.
Debt & Liquidity: The company has no material long-term debt. It maintains $70 million in standby credit lines. Cash and short-term investments totaled $6.77 billion.
Material Changes vs. Prior Period
- Revenue Growth: Q3 revenues increased 39% year-over-year; 9-month revenues increased 49%. Growth was driven by volume increases in software licenses, particularly Windows 95 and Microsoft Office.
- Product Mix Shift: Average selling price per license decreased due to a shift from retail packaged products to OEM and corporate licensing programs, and from new products to upgrades.
- Expense Increases: Research and Development (R&D) expenses rose 66% to $364M (16.5% of revenue) due to hiring and third-party costs. Sales and marketing expenses increased 33% to $685M.
- Balance Sheet: Cash and short-term investments grew from $4.75 billion (June 30, 1995) to $6.77 billion. Unearned revenues increased significantly to $445 million, reflecting ratable revenue recognition for Internet browser updates and support commitments.
Outlook, Risks, and Unusual Items
- Management Commentary: Demand for Windows 95 via retail channels decreased in Q3, reflecting typical upgrade cycles, while OEM demand increased. Over 70% of new PCs shipped in Q3 included Windows 95. Business systems (Windows NT) saw strong corporate demand.
- Strategic Investments: Microsoft established joint ventures with NBC for a 24-hour cable news channel and an interactive online news service, agreeing to pay $220 million over five years for its interest.
- Stock Repurchases: The company continued its open market stock repurchase program, using proceeds from stock option exercises. It also sold equity put warrants to enhance the program, with a maximum potential repurchase obligation of $606 million reclassified to liabilities.
- Risks & Contingencies: The company is subject to various legal proceedings, though management believes resolution will not have a material adverse impact. Foreign exchange rates affect operating results; translation impacts were noted for Europe and Other International regions.
- Dividends: Microsoft has not paid cash dividends on its common stock.
Investor Verification Checklist
- Verify the sustainability of the 39% revenue growth rate given the shift to lower-margin OEM and upgrade licensing.
- Monitor the impact of the $300 million unearned revenue related to Internet browser updates and support commitments on future earnings recognition.
- Assess the return on investment for the $220 million NBC joint venture and the $606 million put warrant obligation.
- Review the continued increase in R&D expenses (up 66%) and its correlation with future product pipeline releases.
- Confirm the trend of declining average selling price per license and its long-term effect on gross margins.