10 Telling Tidbits From Microsoft's 10-Q - InformationWeek
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Paul McDougall
Paul McDougall

10 Telling Tidbits From Microsoft's 10-Q

Investors need to look beyond the headlines and read the fine print to understand the real challenges and opportunities facing the world's biggest software company.

We know the big news from Microsoft's quarterly report last week. Xbox and Office sales were through the roof. Windows? Not so much, as tablets chipped away at the company's core operating system franchise. But a deeper look into Microsoft's 10-Q report, filed Thursday with the SEC, reveals plenty of other tidbits that provide insights, large and small, into what CEO Steve Ballmer and his ever-changing executive team will be dealing with in the months ahead. Here are 10 nuggets you might have missed.

On the hook for $150 million to Yahoo. When Microsoft announced its agreement to provide Bing-powered search services for Yahoo, a deal that took full effect late last August, the fine print included a clause which stipulates that Microsoft guarantee Yahoo's search revenues don't fall below pre-deal levels for at least 18 months.

Microsoft now thinks that making good on that agreement could cost it big bucks. "We estimate the total cost of the revenue per search guarantees during the guarantee period could range up to $150 million," Microsoft said in its filing.

Settlements spur $2.7 billion software giveaway. As part of a deal to settle a series of class-action lawsuits that accused it of anticompetitive behavior, Microsoft agreed to provide the plaintiffs with vouchers for free and discounted software. The program is ongoing, and the company is still doling out the certificates—which aren't cheap. "We estimate the total cost to resolve all of the state overcharge class action cases will range between $1.9 billion and $2.0 billion," Microsoft said.

Cloud computing carries risks. "We are incurring costs to build and maintain infrastructure to support cloud computing services" like Windows Azure and SQL Azure, Microsoft stated. "While we believe our expertise, investments in infrastructure, and the breadth of our cloud-based services provide us with a strong foundation to compete, it is uncertain whether our strategies will attract the users or generate the revenue required to be successful."

OEMs aren’t as important as they used to be. Microsoft has always depended on Dell, Hewlett-Packard, and other PC makers to get its Windows operating system into the hands of end users. But those vendors aren’t as important to Microsoft as they used to be as the company moves more products to the cloud. As a result, OEM sales as a percentage of total Windows revenue fell to 75% in the past quarter, down from its typical mark of around 80%.

Look for this trend to continue as Microsoft embraces the cloud even more aggressively and PC makers diversify their offerings with non-Windows tablets.

Big hardware sales mean bigger costs. Microsoft is raking in more cash than ever. Indeed, its quarterly revenue of $19.95 billion was a company record. But all those extra sales are coming at a price. A good chunk of Microsoft's growth was driven by consumer purchases of Xbox and the Kinect motion controller.

But hardware, which must be manufactured, imported, and shipped to stores on gas-guzzling trucks, carries significantly lower profit margins than software. Microsoft's costs jumped significantly. "Cost of revenue increased $1.2 billion or 33%, primarily reflecting increased volumes of Xbox 360 consoles and accessories sold and higher costs associated with our online offerings," Microsoft said.

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