Microsoft Form 10-Q: Q3 FY2011

Key insights

7 takeaways

01
As of March 31, 2011, Microsoft faced approximately 50 active patent infringement cases, with $1.0 billion in current liabilities and $301 million in long-term liabilities accrued for contingent legal matters.
02
The Entertainment and Devices Division, which includes Xbox 360 and Kinect, is highly seasonal, typically generating 40% of its annual segment revenue during the second fiscal quarter.
03
In June 2010, Microsoft issued $1.25 billion in zero-coupon convertible debt, allocating $1.18 billion to debt and $58 million to stockholders' equity, while entering into capped call transactions to mitigate potential earnings dilution.
04
The company reported a securities lending payable balance of $1.2 billion as of March 31, 2011, with average quarterly balances reaching $1.3 billion.
05
Server and Tools revenue grew 11% year-over-year, driven by strong performance in Windows Server, SQL Server, Enterprise CAL Suites, and Windows Embedded.
06
Microsoft maintains a significant portion of its cash and short-term investments in foreign subsidiaries and does not currently intend to repatriate these funds to the U.S.
07
Management estimates that $214 million of net derivative losses currently held in other comprehensive income will be reclassified into earnings within the next 12 months.

Summary

Microsoft’s financial performance for the third quarter of fiscal year 2011 reflects a period of robust growth driven by strong demand for the Xbox 360 platform, Kinect sensors, Office 2010, and Server and Tools products. Despite a decline in Windows 7 sales, the company achieved increased revenue and operating income, bolstered by a strategic shift toward lower-tax foreign jurisdictions and a favorable IRS audit settlement that reduced the effective tax rate to 13%. During this period, the company maintained a strong liquidity position with $50.2 billion in cash and short-term investments, while continuing to execute a $40 billion share repurchase program.

The company’s strategic focus during this quarter centered on expanding its market presence through the formalization of a partnership with Nokia to establish Windows Phone as a primary smartphone platform. While the Entertainment and Devices Division experienced a 69% surge in revenue, the company faced rising operating expenses attributed to increased marketing investments and headcount-related costs. Financial stability was supported by the issuance of $10.8 billion in senior unsecured notes, which provided capital for acquisitions and ongoing share repurchases.

Operational risks remain a significant consideration, as the company navigates ongoing antitrust litigation, patent infringement claims, and the competitive pressures of transitioning to cloud-based services. Management continues to utilize derivative instruments to hedge against foreign currency, interest rate, and equity price fluctuations, maintaining a AAA credit rating. Looking forward, Microsoft faces the dual challenge of managing cybersecurity vulnerabilities and the high infrastructure costs associated with its online services, all while balancing the need for innovation against the potential for supply chain disruptions and global economic volatility.