Microsoft Corporation 10-Q Summary: Quarter Ended December 31, 2009
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended December 31, 2009 (Fiscal Year 2010, Q2). Microsoft Corporation reported strong financial performance driven primarily by the October 22, 2009 launch of Windows 7. The company operates through five segments: Windows & Windows Live, Server and Tools, Online Services, Microsoft Business Division, and Entertainment and Devices.
Key Financial Metrics
| Metric (in millions) | Q2 2009 | Q2 2008 | YTD 6 Months 2009 | YTD 6 Months 2008 |
|---|---|---|---|---|
| Revenue | $19,022 | $16,629 | $31,942 | $31,690 |
| Operating Income | $8,513 | $5,939 | $12,995 | $11,938 |
| Net Income | $6,662 | $4,174 | $10,236 | $8,547 |
| Diluted EPS | $0.74 | $0.47 | $1.14 | $0.94 |
| Operating Margin | 44.8% | 35.7% | 40.7% | 37.7% |
| Cash & Short-term Investments | $36,099 | N/A | N/A | N/A |
| Total Debt (Short + Long) | $5,995 | N/A | N/A | N/A |
Note: Balance sheet figures are as of December 31, 2009. Total Debt includes $2.25 billion in commercial paper and $3.75 billion in long-term debt.
Material Changes vs. Prior Period
- Revenue Growth: Revenue increased 14% year-over-year for the quarter, primarily due to Windows 7 sales. The Windows & Windows Live Division saw a 70% revenue increase.
- Profitability: Operating income surged 43% year-over-year. Net income increased 60% to $6.66 billion.
- Expense Management: Cost of revenue decreased 7% due to lower Xbox 360 console costs. R&D expenses dropped 9% due to headcount reductions and capitalization of software costs. However, General and Administrative expenses rose 35% due to increased legal charges.
- Segment Performance:
- Windows & Windows Live: Operating income nearly doubled (99% increase) driven by OEM and retail sales.
- Entertainment and Devices: Operating income increased 188% despite an 11% revenue decline, driven by significant cost reductions in console manufacturing.
- Online Services: Operating loss widened 46% due to increased traffic acquisition costs and declining advertising revenue.
- Cash Flow: Net cash from operations for the six months ended Dec 31, 2009 was $11.1 billion, an increase of $1.9 billion compared to the prior year period.
Guidance, Outlook, and Risks
Management Commentary: Management expressed confidence in the company's market position and product delivery plans, noting that demand correlates with global macroeconomic factors. While potential for improvement in 2010 exists, the timing is uncertain. The company remains focused on expense management and delivering high-value products.
Strategic Initiatives:
- Yahoo! Agreement: Entered a definitive 10-year agreement on December 4, 2009, to provide the exclusive search platform for Yahoo! websites, pending regulatory review.
- Share Repurchases: Repurchased 125 million shares in Q2 2009 ($3.6 billion). Approximately $29.5 billion remains of the $40 billion repurchase program authorized in 2008.
- Dividends: Declared a quarterly dividend of $0.13 per share.
Risks and Contingencies:
- Legal Proceedings: Significant exposure remains regarding antitrust and intellectual property litigation. The company has accrued approximately $900 million in current and $400 million in long-term liabilities for contingencies, with a potential additional exposure of up to $1.0 billion.
- European Commission: Concluded an investigation into web browsing software competition via binding commitments (browser choice screen) but faces ongoing investigations regarding Office interoperability.
- Patent Litigation: Ongoing disputes include cases with Alcatel-Lucent, Uniloc, and i4i, with potential for significant damages or injunctions.
Investor Verification Checklist
- Windows 7 Revenue Recognition: Verify the impact of the "Windows 7 Deferral" reversal on Q2 revenue, which significantly boosted reported figures compared to Q1.
- Legal Accruals: Review Note 15 (Contingencies) for details on the $1.3 billion total accrued liability and the potential for an additional $1.0 billion in adverse outcomes.
- Online Services Losses: Assess the sustainability of the Online Services Division's operating loss, which widened due to high traffic acquisition costs.
- Debt Covenants: Confirm compliance with the credit facility covenant requiring a coverage ratio of at least three times EBITDA to interest expense.
- Investment Portfolio: Review Note 4 and 6 for details on unrealized losses ($148 million) and the classification of investments (Level 1, 2, and 3) to assess market risk exposure.