Microsoft Corporation 10-Q Summary: Quarter Ended December 31, 2010
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended December 31, 2010 (Fiscal Year 2011, Q2). Microsoft Corporation operates as a large accelerated filer, providing software, services, and hardware including operating systems (Windows), productivity applications (Office), server tools, online services (Bing, Xbox LIVE), and gaming consoles (Xbox 360). The company reported strong holiday season performance, particularly in its Entertainment and Devices Division.
Key Financial Metrics
| Metric | Three Months Ended Dec 31, 2010 | Six Months Ended Dec 31, 2010 |
|---|---|---|
| Revenue | $19,953 million | $36,148 million |
| Operating Income | $8,165 million | $15,281 million |
| Net Income | $6,634 million | $12,044 million |
| Diluted EPS | $0.77 | $1.39 |
| Operating Margin | 40.9% | 42.3% |
| Cash from Operations (6mo) | $12,380 million | |
| Total Cash & Investments | $41,252 million (as of Dec 31, 2010) | |
| Long-Term Debt | $9,671 million | |
| Short-Term Debt | $0 million |
Material Changes vs. Prior Period
- Revenue Growth: Revenue increased 5% year-over-year for the quarter and 13% for the six-month period. Growth was driven by strong sales of the Xbox 360 console (including the new Kinect sensor), the 2010 Microsoft Office system, and Server and Tools products.
- Operating Income: Operating income decreased 4% for the quarter ($8.17B vs $8.51B) due to higher operating expenses, though it increased 18% for the six-month period ($15.28B vs $12.99B).
- Expense Trends: Cost of revenue rose 33% for the quarter, primarily due to increased Xbox 360 volumes and online offering costs. General and administrative expenses decreased 20% due to lower legal charges and severance costs.
- Segment Performance:
- Entertainment and Devices: Revenue surged 55% and operating income rose 86%, led by Kinect and Xbox 360 sales.
- Windows & Windows Live: Revenue declined 30% year-over-year for the quarter, largely due to the recognition of $1.7 billion in deferred revenue related to the Windows 7 launch in the prior year.
- Microsoft Business Division: Revenue grew 24% driven by the 2010 Office system release.
- Capital Allocation: The company repurchased $5.0 billion of common stock in the quarter and $9.0 billion for the six-month period. Dividends declared were $0.16 per share.
Outlook, Risks, and Contingencies
- Guidance: The filing does not contain specific forward-looking financial guidance for future quarters. Management notes that global macroeconomic factors remain dynamic and uncertain.
- Legal Contingencies:
- Antitrust Settlements: Microsoft has recorded a liability of approximately $593 million related to state overcharge class action settlements, with a total estimated cost between $1.9 billion and $2.0 billion.
- Patent Litigation: Significant cases include the i4i patent dispute regarding Word XML (pending Supreme Court review) and the Alcatel-Lucent case regarding user interface patents (damages retrial scheduled for July 2011).
- Yahoo! Agreement: Microsoft entered a 10-year search agreement with Yahoo!, including revenue per search guarantees estimated to cost up to $150 million.
- Risk Factors: Key risks include intense competition in cloud computing, challenges to the license-based software model from open-source alternatives, intellectual property infringement claims, and security vulnerabilities in products.
- Unusual Items: The prior year included significant revenue recognition from the "Windows 7 Deferral" and "Office Deferral," which distorts year-over-year comparisons for the Windows and Business divisions.
Investor Verification Checklist
- Windows 7 Deferral Impact: Verify the extent to which the 30% revenue decline in the Windows division is attributable to the prior year's deferral recognition rather than organic market decline.
- Xbox 360 Margins: Assess the sustainability of the 86% operating income growth in the Entertainment and Devices division given the high cost of revenue associated with Kinect and console hardware.
- Legal Exposure: Monitor the outcome of the i4i Supreme Court case and the Alcatel-Lucent damages retrial, as these could result in significant additional liabilities beyond the $877 million currently accrued.
- Cloud Transition: Evaluate the progress of the Online Services Division, which reported an operating loss of $562 million for the quarter, as Microsoft shifts strategy toward cloud-based services.
- Share Repurchase Runway: Confirm the remaining $14.7 billion in the $40 billion repurchase program and its potential impact on future earnings per share.