Microsoft Corporation 10-Q Summary: Quarter Ended March 31, 2010
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended March 31, 2010 (Fiscal Year 2010, Q3). Microsoft Corporation is a large accelerated filer incorporated in Washington. The company generates revenue through the development, manufacturing, licensing, and support of software products (Windows, Office, Server), online services (Bing, Xbox LIVE), and hardware (Xbox 360, Zune).
Key Financial Metrics
| Metric | Three Months Ended Mar 31, 2010 | Nine Months Ended Mar 31, 2010 |
|---|---|---|
| Revenue | $14,503 million | $46,445 million |
| Operating Income | $5,173 million | $18,168 million |
| Net Income | $4,006 million | $14,242 million |
| Diluted EPS | $0.45 | $1.59 |
| Operating Margin | 35.7% | 39.1% |
| Cash from Operations (9mo) | $18,469 million | |
| Total Cash & Short-Term Investments | $39,666 million (as of Mar 31, 2010) | |
| Long-Term Debt | $3,746 million | |
| Short-Term Debt | $2,249 million |
Material Changes vs. Prior Period
- Revenue Growth: Revenue increased 6% year-over-year for the quarter and 2% for the nine-month period. Growth was driven by strong sales of Windows 7 and PC market improvement, partially offset by the deferral of $305 million in revenue related to the Office 2010 upgrade guarantee.
- Profitability: Operating income rose 17% for the quarter and 11% for the nine-month period. Diluted EPS increased 36% (quarter) and 24% (nine months), aided by share repurchases (250 million shares in the last 12 months).
- Expense Management: Cost of revenue decreased 2% (quarter) and 4% (nine months) due to lower Xbox 360 console costs. Research and development expenses decreased 6% for the nine-month period due to capitalization of software development costs. General and administrative expenses increased 26% (quarter) and 15% (nine months) primarily due to legal charges and transition expenses for the Yahoo! Commercial Agreement.
- Segment Performance:
- Windows & Windows Live: Revenue up 28% (quarter) driven by Windows 7 OEM and retail sales.
- Online Services: Operating loss widened to $738 million (quarter) due to increased transition expenses for the Yahoo! deal and higher traffic acquisition costs.
- Microsoft Business Division: Revenue declined 6% (quarter) due to the Office 2010 revenue deferral.
- Entertainment & Devices: Operating income turned positive ($138 million) from a loss in the prior year, driven by reduced Xbox 360 console costs.
Guidance, Outlook, and Risks
Outlook: Management notes that demand correlates with global macroeconomic factors. While potential for improvement in calendar year 2010 exists, the timing is uncertain. The company remains focused on executing product delivery plans and managing expenses.
Key Risks and Contingencies:
- Legal Proceedings: Significant ongoing litigation includes antitrust matters in the EU and US, and patent disputes (e.g., Alcatel-Lucent, i4i, VirnetX). As of March 31, 2010, the company accrued approximately $1.1 billion for contingent matters, with a potential additional exposure of up to $1.1 billion beyond recorded amounts.
- Yahoo! Agreement: A 10-year agreement to provide search technology to Yahoo! is subject to performance-based termination after five years. Transition expenses impacted current period results.
- Revenue Recognition: The "Office 2010 Deferral" and "Windows 7 Deferral" impact the timing of revenue recognition, creating volatility in quarterly results.
- Market Risks: Exposure to foreign currency, interest rates, and equity prices. Total one-day Value-at-Risk (VaR) was $234 million as of March 31, 2010.
Investor Verification Checklist
- Revenue Deferrals: Verify the impact of the Office 2010 upgrade guarantee on future revenue recognition timing.
- Yahoo! Integration: Monitor the financial impact of the Yahoo! Commercial Agreement transition costs and the long-term revenue potential of the search partnership.
- Legal Exposure: Review updates on patent litigation (i4i, VirnetX) and antitrust settlements, as outcomes could materially impact financial statements.
- Share Repurchases: Confirm the remaining balance of the $40 billion repurchase program ($27.5 billion remaining as of March 31, 2010) and its impact on EPS.
- Xbox 360 Costs: Assess the sustainability of reduced console costs and their effect on the Entertainment and Devices Division margins.