MSFT

Business Context and Reporting Period

Company: Microsoft Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2008 (First Quarter of Fiscal Year 2009)
Business Overview: Microsoft develops, manufactures, licenses, and supports software products and services for computing devices, including operating systems, server applications, productivity software, and online services. The company also designs and sells hardware, such as the Xbox 360 console and Zune media player.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenue increased 9% year-over-year, driven by increased licensing of the 2007 Microsoft Office system, Windows Server, and SQL Server. Foreign currency exchange rates contributed a $439 million increase.
• Operating Expenses: Total operating expenses rose 14.5% to $9.06 billion. Research and Development (R&D) expenses increased 24% and Sales and Marketing expenses increased 13%, primarily due to a 14% increase in headcount over the past 12 months.
• Other Income: Other income turned negative at $(8) million compared to $367 million in the prior year. This was due to a $179 million loss on foreign currency remeasurements and $165 million in net losses on derivatives, offsetting gains on investments.
• Cash Flow: Net cash from operations decreased $2.5 billion to $3.37 billion, largely due to a $3.1 billion payment to the IRS settling a 2000-2003 examination.
• Debt: The company established a commercial paper program and issued approximately $2.0 billion in short-term debt during the quarter to support liquidity.

Guidance, Outlook, and Risks

• Outlook: Management expects economic conditions for the remainder of fiscal year 2009 to broadly continue as experienced in the first quarter. They anticipate PC shipments will grow between 8% and 12%.
• Share Repurchases: On September 22, 2008, the Board approved a new $40.0 billion share repurchase program. During the quarter, the company repurchased 223 million shares for $6.0 billion.
• Dividends: A quarterly dividend of $0.13 per share was declared, payable in December 2008.
• Legal Contingencies:
  • European Commission: Paid a $1.4 billion fine in June 2008 related to competition law; the company is appealing the fine.
  • Antitrust Settlements: Estimated total cost to resolve U.S. antitrust class actions is between $1.7 billion and $1.9 billion; $900 million is currently accrued.
  • Patent Litigation: Ongoing disputes with Alcatel-Lucent and the Multimedia Patent Trust (MPT). A $512 million verdict against Microsoft regarding user interface patents was appealed.
• Investment Portfolio: The company recorded $72 million in other-than-temporary impairments on investments due to credit market stresses and stock market declines.

Investor Verification Checklist

• IRS Settlement Impact: Verify the cash flow impact of the $3.1 billion IRS payment and confirm no further material tax liabilities are expected from the 2000-2003 examination.
• Investment Impairments: Monitor the $72 million impairment charge and assess the risk of further "other-than-temporary" impairments given the volatile credit market environment.
• Legal Exposure: Track the status of the European Commission appeal and the Alcatel-Lucent patent litigation, as adverse outcomes could result in significant additional costs beyond the $500 million currently accrued for other contingencies.
• Share Repurchase Execution: Confirm the pace of the new $40 billion buyback program and its impact on future earnings per share.
• Segment Performance: Review the Online Services Business segment, which reported an operating loss of $480 million (an 80% increase in loss year-over-year), to assess the timeline for profitability.