Microsoft 2007 Annual Report Download - page 25

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
headcount-related costs. During fiscal year 2007, we incurred $511 million of legal charges primarily related to
antitrust and unfair competition consumer class actions, intellectual property claims, and extension payment to
Sun Microsystems, Inc. as compared to $1.32 billion of legal charges in fiscal year 2006. Headcount-related costs
increased 15% during fiscal year 2007, driven by a 12% increase in headcount and an increase in salaries and
benefits for existing headcount. General and administrative costs decreased in fiscal year 2006 primarily reflecting
decreased costs for legal settlements and legal contingencies. During fiscal year 2006, we incurred $1.32 billion
of legal charges primarily related to antitrust and unfair competition consumer class actions, intellectual property
claims, and an extension payment to Sun Microsystems, Inc. Legal charges in fiscal year 2006 also included
settlement expense of $361 million related to our settlement with RealNetworks, Inc. and the €281 million ($351
million) European Commission fine. Headcount-related costs increased 7% during fiscal year 2006, driven by an
18% increase in headcount and an increase in salaries for existing headcount. We incurred $2.31 billion in legal
charges during fiscal year 2005.
Investment Income and Other
The components of investment income and other were as follows:
(In millions) 2007 2006 2005
Dividends and interest $1,319 $1,510 $1,460
Net gains on investments 650 161 856
Net losses on derivatives (358) (99) (262)
Other, net (34) 218 13
Investment income and other $1,577 $1,790 $2,067
For fiscal year 2007, dividends and interest income declined, reflecting a decline in the average balance of
dividend and interest-bearing investments, partly offset by higher interest rates received on our fixed-income
investments. For fiscal year 2006, dividends and interest income increased due to higher interest rates received
on our fixed-income investments, partially offset by a decline in the average balance of dividend and interest-
bearing investments as a result of the $32.64 billion special dividend paid on December 2, 2004, and stock
repurchases made throughout fiscal year 2006.
For fiscal year 2007, net gains on investments increased primarily due to lower other-than-temporary
impairments and gains on sales of fixed-income investments in the current period as compared to losses in fiscal
year 2006, partly offset by fewer gains on the sale of equity investments. Other-than-temporary impairments in
fiscal year 2007 were not material and were $408 million in fiscal year 2006. Net gains on investments decreased
in fiscal year 2006 primarily due to increased net losses on sales of fixed-income investments, higher other-than-
temporary impairments, and fewer net gains on equity investments in fiscal year 2006 as compared to fiscal year
2005. For fiscal year 2006, other-than-temporary impairments were $408 million, as compared to $152 million in
fiscal year 2005. The increase in other-than-temporary impairments in fiscal year 2006 was driven by planned
sales of certain investments in an unrealized loss position in order to raise funds for the $20 billion tender offer
announced on July 20, 2006.
Investments are considered to be impaired when a decline in fair value is judged to be other than temporary.
We employ a systematic methodology that considers available evidence in evaluating potential impairment of our
investments. If the cost of an investment exceeds its fair value, among other factors, we evaluate general market
conditions, the duration and extent to which the fair value is less than cost, and our intent and ability to hold the
investment. We also consider specific adverse conditions related to the financial health of and business outlook
for the investee, including industry and sector performance, changes in technology, operational and financing
cash flow factors, and rating agency actions. Once a decline in fair value is determined to be other than
temporary, an impairment charge is recorded and a new cost basis in the investment is established.
We lend certain fixed-income and equity securities to increase investment returns. The loaned securities
continue to be carried as investments on our balance sheet. Collateral and/or security interest is determined
based upon the underlying security and the creditworthiness of the borrower. Cash collateral is recorded as an
asset with a corresponding liability. We anticipate that the magnitude of securities lent under this program will
remain relatively consistent during the fiscal year.