Microsoft Corporation 10-Q Summary
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended December 31, 2007, and the six-month period ended on the same date. Microsoft Corporation develops, manufactures, licenses, and supports a wide range of software products, including operating systems (Windows), productivity applications (Office), server tools, and online services. The company also operates the Entertainment and Devices Division, which includes the Xbox 360 platform and Zune digital music devices.
Key Financial Metrics
| Metric (in millions) | 3 Months Ended Dec 31, 2007 | 3 Months Ended Dec 31, 2006 | 6 Months Ended Dec 31, 2007 | 6 Months Ended Dec 31, 2006 |
|---|---|---|---|---|
| Revenue | $16,367 | $12,542 | $30,129 | $23,353 |
| Operating Income | $6,481 | $3,472 | $12,399 | $7,946 |
| Net Income | $4,707 | $2,626 | $8,996 | $6,104 |
| Diluted EPS | $0.50 | $0.26 | $0.95 | $0.61 |
| Cash from Operations | $4,567 | $2,042 | $10,445 | $6,103 |
| Cash & Equivalents (Balance Sheet) | $7,460 (as of Dec 31, 2007) | |||
| Total Assets | $67,339 (as of Dec 31, 2007) |
Margins: Operating margin for the three months ended December 31, 2007, was approximately 39.6% ($6,481 / $16,367). Net margin was approximately 28.8%.
Debt & Liquidity: The company reported no material long-term debt. Total cash, cash equivalents, and short-term investments totaled $21.1 billion as of December 31, 2007.
Material Changes vs. Prior Period
- Revenue Growth: Revenue increased 30% year-over-year for the quarter and 29% for the six-month period. Growth was driven by licensing of Windows Vista and the 2007 Microsoft Office system, increased Xbox console and game sales, and growth in Windows Server and SQL Server.
- Operating Income: Operating income surged 87% for the quarter and 56% for the six-month period. This outpaced revenue growth due to favorable product mix and operating leverage, despite increased headcount and legal charges.
- Acquisitions: The company acquired aQuantive, Inc. for $5.9 billion in August 2007, significantly impacting the Online Services Business segment and adding $5.3 billion in goodwill.
- Legal Charges: Legal charges increased to $237 million for the quarter (vs. $111 million prior year) and $277 million for the six months (vs. $198 million prior year), primarily related to settlements and contingencies.
- Segment Performance:
- Client: Revenue up 68% (quarter) driven by Windows Vista OEM licensing.
- Entertainment and Devices: Turned profitable with operating income of $357 million (vs. loss of $306 million prior year) due to decreased Xbox 360 manufacturing costs and increased game sales.
- Online Services: Operating loss widened to $248 million (vs. $116 million prior year) due to increased costs and amortization related to the aQuantive acquisition.
Guidance, Outlook, and Risks
Outlook: Management expects double-digit revenue growth for fiscal year 2008. They anticipate worldwide PC shipments will grow 11% to 13%. Operating income growth is expected to continue to exceed revenue growth. The company expects a favorable impact from foreign currency exchange rates.
Capital Allocation: As of December 31, 2007, approximately $8.7 billion remained of the $36.2 billion authorized for share repurchases. The company declared a quarterly dividend of $0.11 per share.
Risks and Contingencies:
- Legal Proceedings: Significant exposure remains regarding antitrust matters in the EU and US, and patent litigation (notably with Alcatel-Lucent). The company estimates potential costs beyond recorded amounts could be up to $4.1 billion in aggregate.
- Tax Uncertainty: Adoption of FIN 48 resulted in a $395 million charge to retained deficit. The company has $7.1 billion in unrecognized tax benefits, with $5.3 billion potentially affecting the effective tax rate if recognized.
- Competition: Risks include open-source software models (e.g., Linux) and software-as-a-service competitors challenging the traditional license-based model.
Investor Verification Checklist
- Revenue Recognition Timing: Verify the impact of the "Express Upgrade" and "Technology Guarantee" programs on revenue deferrals in prior periods versus recognition in the current period.
- Legal Exposure: Review the specific status of the European Commission competition law investigations and the Alcatel-Lucent patent litigation to assess the $4.1 billion potential exposure.
- Acquisition Integration: Monitor the integration of aQuantive and its impact on the Online Services Business operating loss and future advertising revenue growth.
- Goodwill Impairment: Assess the $10.3 billion goodwill balance (up from $4.76 billion) for potential impairment risks given the significant increase from acquisitions.
- Share Repurchase Activity: Track the execution of the remaining $8.7 billion repurchase authorization and its impact on earnings per share.