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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 1999
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From _____ to ____
______________________
Commission File Number 0-14278
MICROSOFT CORPORATION
(Exact name of registrant as specified in its charter)
Washington 91-1144442
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Microsoft Way, Redmond, Washington 98052-6399
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (425) 882-8080
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [_]
The number of shares outstanding of the registrant's common stock
as of April 30, 1999 was 5,103,859,232.
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MICROSOFT CORPORATION
FORM 10-Q
For the Quarter Ended March 31, 1999
INDEX
Part I. Financial Information
Item 1. Financial Statements Page
----
a) Income Statements
for the Three and Nine Months Ended March 31, 1998 and 1999.......... 1
b) Balance Sheets
as of June 30, 1998 and March 31, 1999............................... 2
c) Cash Flows Statements
for the Nine Months Ended March 31, 1998 and 1999.................... 3
d) Stockholders' Equity Statements
for the Three and Nine Months Ended March 31, 1998 and 1999.......... 4
e) Notes to Financial Statements........................................ 5
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations..................................... 9
Part II. Other Information
Item 1. Legal Proceedings....................................................... 14
Item 2. Changes in Securities and Use of Proceeds............................... 14
Item 4. Submission of Matters to a Vote of Security Holders..................... 14
Item 6. Exhibits and Reports on Form 8-K........................................ 14
Signature.......................................................................... 15
Part I. Financial Information
Item 1. Financial Statements
MICROSOFT CORPORATION
INCOME STATEMENTS
(In millions, except earnings per share)(Unaudited)
________________________________________________________________________________
Three Months Ended Nine Months Ended
Mar. 31 Mar. 31
1998 1999 1998 1999
- ---------------------------------------------------------------------------------------------------------------
Revenue $3,774 $4,331 $10,489 $13,222
Operating expenses:
Cost of revenue 317 350 883 1,090
Research and development 597 611 1,791 1,889
Acquired in-process technology 0 0 296 0
Sales and marketing 829 996 2,493 2,766
General and administrative 104 144 305 392
Other expenses 60 1 181 60
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Total operating expenses 1,907 2,102 5,949 6,197
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Operating income 1,867 2,229 4,540 7,025
Investment income 190 720 489 1,318
Gain on sale 0 0 0 160
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Income before income taxes 2,057 2,949 5,029 8,503
Provision for income taxes 720 1,032 1,896 2,920
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Net income $1,337 $1,917 $ 3,133 $ 5,583
===============================================================================================================
Earnings per share (1):
Basic $ 0.27 $ 0.38 $ 0.64 $ 1.11
===============================================================================================================
Diluted $ 0.25 $ 0.35 $ 0.59 $ 1.02
===============================================================================================================
(1) Earnings per share amounts for the three and nine months ended March 31,
1998 have been restated to reflect a two-for-one stock split in March 1999.
See accompanying notes.
________________________________________________________________________________
1
MICROSOFT CORPORATION
BALANCE SHEETS
(In millions)
________________________________________________________________________________
June 30 Mar. 31
1998 1999 (1)
- ---------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and short-term investments $13,927 $21,761
Accounts receivable 1,460 1,689
Other 502 608
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Total current assets 15,889 24,058
Property and equipment 1,505 1,445
Equity investments 4,703 7,474
Other assets 260 584
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Total assets $22,357 $33,561
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Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 759 $ 1,016
Accrued compensation 359 289
Income taxes payable 915 1,347
Unearned revenue 2,888 4,195
Other 809 992
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Total current liabilities 5,730 7,839
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Commitments and contingencies
Stockholders' equity:
Convertible preferred stock -
shares authorized 100; outstanding 13 980 980
Common stock and paid-in capital -
shares authorized 12,000; outstanding 4,940 and 5,091 8,025 12,418
Retained earnings 7,622 12,324
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Total stockholders' equity 16,627 25,722
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Total liabilities and stockholders' equity $22,357 $33,561
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(1) Unaudited
See accompanying notes.
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2
MICROSOFT CORPORATION
CASH FLOWS STATEMENTS
(In millions)(Unaudited)
________________________________________________________________________________
Nine Months Ended
Mar. 31
1998 1999
- -----------------------------------------------------------------------------------------------
Operations
Net income $ 3,133 $ 5,583
Depreciation and amortization 776 514
Write-off of acquired in-process technology 296 0
Gain on sale 0 (160)
Unearned revenue 2,139 4,139
Recognition of unearned revenue from prior periods (1,094) (2,832)
Other current liabilities 266 471
Accounts receivable (123) (192)
Other current assets 53 (104)
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Net cash from operations 5,446 7,419
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Financing
Common stock issued 650 1,102
Common stock repurchased (1,605) (1,527)
Put warrant proceeds 388 757
Preferred stock dividends (21) (21)
Stock option income tax benefits 910 2,238
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Net cash from financing 322 2,549
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Investments
Additions to property and equipment (415) (291)
Cash portion of WebTV purchase price (190) 0
Cash proceeds from sale of Softimage 0 79
Equity investments and other (1,756) (1,899)
Short-term investments (2,952) (5,532)
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Net cash used for investments (5,313) (7,643)
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Net change in cash and equivalents 455 2,325
Effect of exchange rates on cash and equivalents (51) 39
Cash and equivalents, beginning of period 3,706 3,839
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Cash and equivalents, end of period 4,110 6,203
Short-term investments, end of period 8,212 15,558
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Cash and short-term investments, end of period $12,322 $21,761
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See accompanying notes.
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3
MICROSOFT CORPORATION
STOCKHOLDERS' EQUITY STATEMENTS
(In millions)(Unaudited)
________________________________________________________________________________
Three Months Ended Nine Months Ended
Mar. 31 Mar. 31
1998 1999 1998 1999
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Convertible preferred stock
Balance $ 980 $ 980 $ 980 $ 980
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Common stock and paid-in capital
Balance, beginning of period 6,104 10,443 4,509 8,025
Common stock issued 323 901 949 1,771
Common stock repurchased (9) (20) (100) (45)
Structured repurchases price differential 0 (328) 328 (328)
Proceeds from sale of put warrants 63 402 388 757
Stock option income tax benefits 503 1,020 910 2,238
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Balance, end of period 6,984 12,418 6,984 12,418
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Retained earnings
Balance, beginning of period 5,260 11,155 5,288 7,622
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Net income 1,337 1,917 3,133 5,583
Net unrealized investments gains 167 46 297 586
Translation adjustments and other (45) (52) (152) 54
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Comprehensive income 1,459 1,911 3,278 6,223
Preferred stock dividends (7) (7) (21) (21)
Common stock repurchased 0 (735) (1,833) (1,500)
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Balance, end of period 6,712 12,324 6,712 12,324
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Total stockholders' equity $14,676 $25,722 $14,676 $25,722
==========================================================================================================
See accompanying notes.
________________________________________________________________________________
4
MICROSOFT CORPORATION
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
________________________________________________________________________________
Basis of Presentation
In the opinion of management, the accompanying balance sheets and related
interim statements of income, cash flows, and stockholders' equity include all
adjustments (consisting only of normal recurring items) necessary for their fair
presentation in conformity with generally accepted accounting principles.
Preparing financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenue,
and expenses. Examples include provisions for returns and bad debts and the
length of product life cycles and buildings' lives. Actual results may differ
from these estimates. Interim results are not necessarily indicative of results
for a full year. The information included in this Form 10-Q should be read in
conjunction with Management's Discussion and Analysis and financial statements
and notes thereto included in the Microsoft Corporation 1998 Form 10-K.
Stock Split
In March 1999, outstanding shares of common stock were split two-for-one. All
prior share and per share amounts have been restated to reflect the stock split.
Earnings Per Share
Basic earnings per share is computed on the basis of the weighted average number
of common shares outstanding. Diluted earnings per share is computed on the
basis of the weighted average number of common shares outstanding plus the
effect of outstanding preferred shares using the "if-converted" method, assumed
net-share settlement of common stock structured repurchases, and outstanding
stock options using the "treasury stock" method.
The components of basic and diluted earnings per share were as follows:
EARNINGS PER SHARE
(In millions, except earnings per share)
________________________________________________________________________________
Three Months Ended Nine Months Ended
Mar. 31 Mar. 31
1998 1999 1998 1999
- --------------------------------------------------------------------------------------------------------------
Net income (A) $1,337 $1,917 $3,133 $5,583
Preferred stock dividends (7) (7) (21) (21)
- --------------------------------------------------------------------------------------------------------------
Net income available for common shareholders (B) $1,330 $1,910 $3,112 $5,562
==============================================================================================================
Average outstanding shares of common stock (C) 4,866 5,055 4,843 5,004
Dilutive effect of:
Common stock under structured repurchases 10 12 3 17
Preferred stock 30 16 35 20
Employee stock options 464 429 464 428
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Common stock and common stock equivalents (D) 5,370 5,512 5,345 5,469
==============================================================================================================
Earnings per share:
Basic (B/C) $ 0.27 $ 0.38 $ 0.64 $ 1.11
==============================================================================================================
Diluted (A/D) $ 0.25 $ 0.35 $ 0.59 $ 1.02
==============================================================================================================
________________________________________________________________________________
5
Unearned Revenue
A portion of Microsoft's revenue is earned ratably over the product life cycle
or, in the case of subscriptions, over the period of the license agreement.
End-users receive certain elements of the Company's platform products over a
period of time. These elements include browser and other Internet technologies,
telephone support, Internet-based technical support, and service releases.
Consequently, Microsoft recognizes the fair value of these elements, currently
approximately 20% of Windows 98 and Windows 95 desktop operating systems OEM
revenue and approximately 35% of retail version revenue, over the product's life
cycle. Approximately 20% of Windows NT Workstation and Windows NT Server
revenue is also recognized ratably. Product life cycles are currently estimated
at two years. The Company also sells subscriptions to platforms products via
maintenance and certain organizational license agreements. At March 31, 1999,
platform products unearned revenue was $2.06 billion.
Likewise, end-users of the Company's applications products receive elements over
time, including telephone support, new Internet technologies, and service
releases. The fair value of these elements, which is currently approximately
20% of Office 97 applications revenue, is recognized ratably over the estimated
18-month product life cycle. The Company also sells subscriptions to
applications and tools products, including maintenance and certain
organizational license programs. Unearned revenue associated with applications
and tools products totaled $2.02 billion at March 31, 1999.
Unearned revenue associated with other miscellaneous programs totaled $113
million at March 31, 1999.
Stockholders' Equity
Microsoft repurchases its common stock in the open market to provide shares for
issuance to employees under stock option and stock purchase plans. During the
first three quarters of fiscal 1999, the Company repurchased 25.6 million shares
of Microsoft common stock in the open market. During fiscal 1998, the Company
repurchased 42 million shares under forward settlement structured repurchases
and paid cash for a portion of the purchase price. In the March quarter of
fiscal 1999, the Company settled the remainder by returning 28 million shares,
based upon the stock price on the date of settlement. The timing and method of
settlement was at the discretion of the Company. The differential between the
cash paid and the price of Microsoft common stock on the date of the agreement
was originally reflected in common stock and paid-in capital.
To enhance its stock repurchase program, Microsoft sells put warrants to
independent third parties. These put warrants entitle the holders to sell
shares of Microsoft common stock to the Company on certain dates at specified
prices, and permit a net-share settlement at the Company's option. On March 31,
1999, 163 million warrants were outstanding. The outstanding put warrants have
strike prices ranging from $59 to $65 per share and maturities ranging from 6 to
36 months.
During 1996, Microsoft issued 12.5 million shares of 2.75% convertible
exchangeable principal-protected preferred stock. Dividends are payable
quarterly in arrears. Preferred shareholders have preference over common
stockholders in dividends and liquidation rights. In December 1999, each
preferred share is convertible into common shares or an equivalent amount of
cash determined by a formula that provides a floor price of $79.875 and a cap of
$102.24 per preferred share. Net proceeds of $980 million were used to
repurchase common shares.
Acquisitions
In November 1998, Microsoft acquired LinkExchange, Inc., a leading provider of
online marketing services to web site owners and small and medium-sized
businesses. Microsoft paid $265 million in stock. The Company did not record
an in-process technology write-off in connection with the purchase of
LinkExchange.
In August 1997, Microsoft acquired WebTV Networks, Inc., an online service that
enables consumers to experience the Internet through their televisions via set-
top terminals based on proprietary technologies. Microsoft paid $425 million in
stock and cash. The Company recorded an in-process technologies write-off of
$296 million in the first quarter of 1998.
Sale of Softimage
In August 1998, the Company sold a wholly-owned subsidiary, Softimage, Inc. to
Avid Technology, Inc. Microsoft received cash of $79 million and securities
valued at $85 million. A pretax gain of $160 million was recognized in the
first quarter of fiscal 1999. As part of a transitional service agreement,
Microsoft agreed to make certain development tools and management systems
available to Avid for use in the Softimage business.
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6
Contingencies
On October 7, 1997, Sun Microsystems, Inc. brought suit against Microsoft in the
U.S. District Court for the Northern District of California. Sun's Complaint
alleges several claims against Microsoft, all related to the parties'
relationship under a March 11, 1996 Technology License and Distribution
Agreement (Agreement) concerning certain Java programming language technology.
The Complaint seeks: a preliminary and permanent injunction against Microsoft
distributing certain products with the Java Compatibility logo, and against
distributing Internet Explorer 4.0 unless certain alleged obligations are met;
an order compelling Microsoft to perform certain alleged obligations; an
accounting; termination of the Agreement; and an award of damages, including
compensatory, exemplary and punitive damages, and liquidated damages of $35
million for the alleged source code disclosure.
On March 24, 1998, the court entered an order enjoining Microsoft from using the
Java Compatibility logo on Internet Explorer 4.0 and the Microsoft Software
Developers Kit for Java 2.0. Microsoft has taken steps to fully comply with the
order.
On May 12, 1998, Sun filed companion motions seeking a preliminary injunction
based on allegations of copyright infringement and unfair competition. Sun
requested an order enjoining Microsoft from distributing any Java-based
technology in any operating system, browser, or developers tools, including
Windows 98, Internet Explorer 4.0 software, and the Visual J++(TM) 6.0
development system for Java, unless and until Microsoft includes with each such
product an implementation of the Java run-time environment that passes Sun's
compatibility test suite or an operable implementation of Sun's current Java
run-time environment. Hearings on these motions were held in September 1998.
On November 17, 1998, the court entered an order granting Sun's request for a
preliminary injunction, holding that Sun had established a likelihood of success
on its copyright infringement claims because Microsoft's use of Sun's technology
in its products was beyond the scope of the parties' license agreement. The
court ordered Microsoft to make certain changes in its products that include
Sun's Java Technology and to make certain changes in its Java software
development tools. The court also enjoined Microsoft from entering into any
licensing agreements that were conditioned on exclusive use of Microsoft's Java
Virtual Machine. Microsoft appealed that ruling to the 9th Circuit on December
16, 1998. Oral argument on that appeal is set for June 16, 1999. In the
interim, Microsoft is complying with the ruling and has not sought a stay of the
injunction pending appeal. On December 18, 1998, Microsoft filed a motion
requesting an extension of the 90-day compliance period for certain Microsoft
products, which was granted in part in January 1999. Microsoft filed a motion
on February 5, 1999, seeking clarification of the court's order that Microsoft
would not be prevented from engaging in independent development of Java
technology under the order. The court granted that motion. On January 22, 1999,
Microsoft and Sun filed a series of summary judgment motions regarding the
interpretation of the contract and other issues. There are no other hearing or
trial dates set.
On May 18, 1998, the Antitrust Division of the U.S. Department of Justice (DOJ)
and a group of 20 state Attorneys General filed two antitrust cases against
Microsoft in the U.S. District Court for the District of Columbia. The DOJ
complaint alleges violations of Sections 1 and 2 of the Sherman Act. The DOJ
complaint seeks declaratory relief as to the violations it asserts and
preliminary and permanent injunctive relief regarding: the inclusion of Internet
browsing software (or other software products) as part of Windows; the terms of
agreements regarding non-Microsoft Internet browsing software (or other software
products); taking or threatening "action adverse" in consequence of a person's
failure to license or distribute Microsoft Internet browsing software (or other
software product) or distributing competing products or cooperating with the
government; and restrictions on the screens, boot-up sequence, or functions of
Microsoft's operating system products. The state Attorneys General allege
largely the same claims, and various pendent state claims. The states seek
declaratory relief, and preliminary and permanent injunctive relief similar to
that sought by the DOJ, together with statutory penalties under the state law
claims. The foregoing description is qualified in its entirety by reference to
the full text of the complaints and other papers on file in those actions, case
numbers 98-1232 and 98-1233.
On May 22, 1998, Judge Jackson consolidated the two actions. The judge granted
Microsoft's motion for summary judgment as to the states' monopoly leverage
claim, and permitted the remaining claims to proceed to trial. Trial began on
October 19, 1998. Microsoft believes the claims are without merit and is
defending against them vigorously. In other ongoing investigations, the DOJ and
several state Attorneys General have requested information from Microsoft
concerning various issues.
________________________________________________________________________________
7
Caldera, Inc. filed a lawsuit against Microsoft in July 1996. It alleges
Sherman Act violations relating to Microsoft licensing practices of MS-DOS and
Windows in the late 80's and early 90's essentially the same complaints that
resulted in the 1994 DOJ consent decree. Caldera claims to own the rights of
Novell, Inc. and Digital Research Inc. relating to DR-DOS and Novell DOS
products. It also asserts a claim that Windows 95 is a technological tie of
Windows and MS-DOS. Trial is scheduled for January 2000. Summary judgment
motions are pending. Microsoft believes the claims are without merit and is
vigorously defending the case.
Microsoft is also subject to various legal proceedings and claims that arise in
the ordinary course of business.
Management currently believes that resolving these matters will not have a
material adverse impact on the Company's financial position or its results of
operations.
________________________________________________________________________________
8
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
Microsoft develops, manufactures, licenses, and supports a wide range of
software products, including scalable operating systems for intelligent devices,
personal computers (PCs), and servers; server applications for client/server
environments; knowledge worker productivity applications; and software
development tools. The Company's online efforts include the MSN(TM) network of
Internet products and services; e-commerce platforms; and alliances with
companies involved with broadband access and various forms of digital
interactivity. Microsoft also licenses consumer software programs, sells PC
input devices and books, and researches and develops advanced technologies for
future software products.
Revenue
Revenue of $4.33 billion in the March quarter of fiscal 1999 increased 15% over
the third quarter of fiscal 1998. Reported revenue did not include unearned
revenue of $400 million related to the Microsoft(R) Office 2000 Technology
Guarantee. Certain customers acquiring Office 97 or related applications are
entitled to a free upgrade to the corresponding Office 2000 application when
available. This revenue will be earned upon fulfillment of the related upgrade.
Revenue growth reflected the continued adoption of Microsoft Windows(R)
operating systems, including Windows 98, Windows NT(R) Server, and Windows NT
Workstation; along with the Company's server applications. On a year to date
basis, revenue in the first three quarters of fiscal 1999 totaled $13.2 billion,
an increase of 26% over the first three quarters of fiscal 1998. Year to date
revenue growth reflected the continued adoption of Microsoft(R) Windows(R)
operating systems and Microsoft Office.
Software license volume increases have been the principal factor in Microsoft's
revenue growth. The average selling price per license has decreased, primarily
because of general shifts in the sales mix from retail packaged products to
licensing programs, from new products to product upgrades, and from stand-alone
programs to integrated product suites. Average revenue per license from
original equipment manufacturer (OEM) licenses and organizational license
programs is lower than average revenue per license from retail versions.
Likewise, product upgrades have lower prices than new products. Also, prices of
integrated suites, such as Microsoft Office and BackOffice, are less than the
sum of the prices for the individual programs included in these suites when such
programs are licensed separately. An increased percentage of products and
programs included elements that were billed but unearned and recognized ratably,
such as certain platforms and applications programs, maintenance, and other
subscription models. See accompanying notes to financial statements.
Product Groups
Platforms product revenue grew 26% to $2.05 billion in the third quarter.
Revenue of $6.30 billion for the first three quarters of fiscal 1999 grew 38%
over the first three quarters of fiscal 1998. Windows-based units licensed
through the OEM channel, particularly Windows NT Workstation, increased
strongly. Organizational licensing of Windows NT Workstation and Windows 98
also contributed to the growth. Windows NT Server revenue was healthy, although
the growth rate slowed from growth percentages in prior quarters. Windows CE
and Microsoft WebTV Network(TM) service continued to show strong revenue growth,
albeit small in amount.
Applications and Tools product revenue increased 4% to $1.94 billion in the
March quarter. Underlying shipments of desktop applications were strong, led by
Microsoft Office integrated suites, including the Standard, Professional, and
Small Business Editions. However, desktop applications earned revenue actually
decreased from a year ago, due to the impact of the Office 2000 Technology
Guarantee noted above. Server applications revenue, principally Microsoft
Exchange Server and Microsoft SQL Server(TM), increased strongly over the
comparable quarter of the prior year. SQL Server revenue in the March quarter
was very healthy, and also included earned revenue of $45 million related to
fulfillment of free upgrades to SQL Server 7.0, which was treated as unearned
the prior quarter. The Visual Studio(R) 6.0 development system, an integrated
set of software development tools, drove moderate tools revenue growth.
Applications and Tools revenue for the first three quarters of fiscal 1999 grew
17% over the prior year, reflecting strong shipments of Microsoft Office (offset
by the Office 2000 Technology Guarantee) and strong shipments of server
applications.
Interactive Media and Other revenue was $341 million in the third quarter, up
22% from the comparable quarter of fiscal 1998. Online advertising revenue rose
substantially, while revenue from hardware, consumer software, and Microsoft
Press was relatively flat. Year to date revenue was $1.12 billion, up 19% over
the prior year. The year to date increase reflected increased shipments of
hardware products and escalated online advertising.
________________________________________________________________________________
9
Sales Channels
Microsoft distributes its products primarily through OEM licenses,
organizational licenses, and retail packaged products. OEM channel revenue
represents license fees from original equipment manufacturers who pre-install
Microsoft products, primarily on PCs. Microsoft has three major geographic
sales and marketing organizations: the South Pacific and Americas Region; the
Europe, Middle East, and Africa Region; and the Asia Region. Sales of
organizational licenses and packaged products in these channels are primarily to
distributors and resellers.
Third quarter revenue from OEMs of $1.59 billion represented an increase of 29%
over the comparable quarter of fiscal 1998. OEM revenue of $4.75 billion in the
first three quarters of fiscal 1999 increased 39% over the first three quarters
of fiscal 1998. PC shipment growth coupled with an increased penetration of
higher value 32-bit operating systems drove the OEM revenue increase over the
prior year.
For the March quarter, revenue in the South Pacific and Americas Region
increased 6% to $1.33 billion. Growth from Windows NT Server, Windows NT
Workstation, server applications, and online services offset lower earned
revenue from desktop applications. Organization licensing activity was strong.
Revenue growth in the U.S. was moderate, but was relatively flat in Latin
America and the South Pacific. Revenue for the first three quarters of fiscal
1999 grew 23% to $4.34 billion, reflecting strong licensing of Microsoft Office,
Windows NT Server, Windows NT Workstation, Windows 98, and server applications.
In the Europe, Middle East, and Africa Region, third quarter revenue of $932
million was up 4% compared to the third quarter of fiscal 1998. Organizational
licensing of Windows NT Server, Windows NT Workstation, and server applications
grew strongly compared to the prior year, offsetting the decline in desktop
applications earned revenue. Revenue growth continued to be solid in France and
Germany, and was particularly high in the United Kingdom, Sweden, the
Netherlands, and the Middle East. For the first three quarters of fiscal 1999,
revenue in the region totaled $2.97 billion, an increase of 21% over the prior
year. Organizational licensing of Microsoft Office, Windows NT Server, Windows
NT Workstation, and server applications grew strongly compared to the prior
year.
Revenue in the Asia Region in the March quarter of $475 million increased 22%
from the third quarter of the prior year. Desktop applications revenue was
particularly strong. Revenue growth was solid in Japan. Certain areas
exhibited superb growth, including China, India, and Southeast Asia. On a year
to date basis, revenue in the Asia Region was $1.15 billion, up 9% over the
comparable period of the prior year. As discussed below, strengthening local
currencies positively impacted translated revenue compared to the prior year,
particularly in Japan.
Translated international revenue is affected by foreign exchange rates. The
impact of foreign exchange rates on third quarter revenue was positive, as most
local currencies were strong versus the U.S. dollar. Had the rates from the
prior year been in effect in the third quarter of fiscal 1999, translated
international revenue billed in local currencies would have been $55 million
lower. The impact of foreign exchange rates on second quarter revenue was
nominal, as weaknesses in Japanese, Australian, and Southeast Asian currencies
versus the U.S. dollar were offset by the relative strength of European
currencies. Had the rates from the prior year been in effect in the first
quarter, international revenue would have been $100 million higher, due to
weaknesses in currencies versus the U.S. dollar. Certain manufacturing,
selling, distribution, and support costs are disbursed in local currencies, and
a portion of international revenue is hedged, thus offsetting a portion of the
translation exposure.
Operating Expenses, Nonoperating Items, and Income Taxes
Cost of revenue as a percent of revenue was 8.1% in the third quarter, down
slightly from the percent of revenue the prior year. On a year to date basis,
the percentage was 8.2%, which also was slightly less than the percentage the
prior year. The impact of the trend in mix shift to OEM and organizational
licenses on the cost of revenue percentage was offset somewhat by the impact of
unearned revenue related to the Office 2000 Technology Guarantee and increased
costs related to online services.
Research and development expenses increased 2% in the third quarter to $611
million, driven primarily by higher development headcount-related costs offset
by lower infrastructure costs. On a year to date basis, research and
development expenses grew 5% to $1.89 billion, reflecting higher development
headcount-related costs, offset by lower infrastructure costs and third-party
development costs.
In August 1997, the Company acquired WebTV Networks, Inc., an online service
that enables consumers to experience the Internet through their televisions via
set-top terminals. Microsoft paid $425 million in stock and cash for WebTV.
Fiscal 1998 results reflect a one-time write-off of in-process technologies
under development by WebTV of $296 million.
________________________________________________________________________________
10
Sales and marketing expenses were $996 million in the March quarter, which
represented 23.0% of revenue, compared to 22.0% in the third quarter of the
prior year. Total sales and marketing expense as a percent of revenue increased
due to higher relative sales expenses offset by lower relative marketing costs.
On a year to date basis, sales and marketing expenses were $2.77 billion, which
represented 20.9% of revenue, down from 23.8% of revenue for the first three
quarters of fiscal 1998. Expenses as a percent of revenue decreased due to
lower relative sales expenses and marketing costs.
General and administrative costs were $144 million in the third quarter compared
to $104 million in the March quarter of the prior year. Year to date general
and administrative costs were $392 million, up 29% from $305 million the prior
year. The increases were due, in part, to higher legal costs.
Other expenses reflect primarily the recognition of Microsoft's share of joint
venture activities, including DreamWorks Interactive and the MSNBC cable and
online news services.
Third quarter investment income increased to $720 million from $190 million in
the third quarter of the prior year. Year to date investment income totaled
$1.32 billion in fiscal 1999, compared to $489 million the prior year. The
increase was due to the larger investment portfolio generated by cash from
operations, coupled with realized gains of more than $400 million from the sale
of certain bond and equity securities.
In August 1998, Microsoft sold its Softimage subsidiary to Avid Technology, Inc.
A pretax gain of $160 million was recorded in the first quarter of fiscal 1999.
Excluding the tax impact of the gain on the sale of Softimage, the effective tax
rate for fiscal 1999 was 35%, less than the higher effective rate in fiscal 1998
due to a legislative clarification of the foreign sales corporation rules as
they apply to software and the nondeductible write-off of WebTV in-process
technologies.
Financial Condition
Microsoft's cash and short-term investment portfolio totaled $21.76 billion at
March 31, 1999. The portfolio is diversified among security types, industries,
and individual issuers. Microsoft's investments are generally liquid and
investment grade. The portfolio is invested predominantly in U.S. dollar
denominated securities, but also includes foreign currency positions in
anticipation of continued international expansion. The portfolio is primarily
invested in short-term securities to minimize interest rate risk and facilitate
rapid deployment in the event of immediate cash needs.
Microsoft also invests in equity securities, including financial investments and
strategic technology companies in many areas.
Microsoft has no material long-term debt and has $100 million of standby
multicurrency lines of credit to support foreign currency hedging and cash
management. Stockholders' equity at March 31, 1999 was $25.72 billion.
Microsoft will continue to invest in sales, marketing, and product support
infrastructure. Additionally, research and development activities will include
investments in existing and advanced areas of technology, including using cash
to acquire technology. Additions to property and equipment will continue,
including new facilities and computer systems for research and development,
sales and marketing, support, and administrative staff. Commitments for
constructing new buildings were $360 million on March 31, 1999. Cash will also
be used to fund ventures and other strategic opportunities.
In May 1999, the Company agreed to purchase $5 billion of convertible securities
and warrants of AT&T, a premier provider of voice and data communications. In
addition to various technology licensing agreements with AT&T and in connection
with AT&T's proposed merger with MediaOne Group Inc., the Company agreed to
acquire MediaOne's interest in Telewest Communications plc. Telewest is leading
provider of cable television and residential and business cable telephony
services in the United Kingdom. Also, the Company announced its intention to
purchase $600 million of Nextel Communications Inc. common stock. Nextel is a
leading provider of integrated wireless communications in the United States.
The transactions are subject to certain regulatory approvals and other
conditions. In addition to previous investments in broadband service providers
such as Comcast Corporation and NTL Inc., the Company's strategy may include
future investments in broadband and wireless service providers around the world.
Cash will also be used to repurchase common stock to provide shares for employee
stock option and purchase plans. The buyback program has not kept pace with
employee stock option grants or exercises. Beginning in fiscal 1990, Microsoft
has repurchased 691 million common shares while 1.76 billion shares were issued
under the Company's
________________________________________________________________________________
11
employee stock option and purchase plans. The market value of all outstanding
stock options was $72 billion as of March 31, 1999. Microsoft enhances its
repurchase program by selling put warrants. During December 1996, Microsoft
issued 12.5 million shares of 2.75% convertible preferred stock. Net proceeds of
$980 million were used to repurchase common shares.
Management believes existing cash and short-term investments together with funds
generated from operations will be sufficient to meet operating requirements for
the next 12 months. Microsoft's cash and short-term investments are available
for strategic investments, mergers and acquisitions, other potential large-scale
cash needs that may arise, and to fund an increased stock buyback program over
historical levels to reduce the dilutive impact of the Company's employee stock
option and purchase programs.
Microsoft has not paid cash dividends on its common stock. The preferred stock
pays $2.196 per annum per share.
New Accounting Pronouncement
During December 1998, the Accounting Standards Executive Committee (AcSEC) of
the American Institute of Certified Public Accountants issued Statement of
Position (SOP) 98-9, Modification of SOP 97-2, Software Revenue Recognition,
With Respect to Certain Transactions. The SOP is effective for transactions
entered into in fiscal years beginning after March 15, 1999. Management of the
Company is evaluating the new SOP and related interpretive guidance. The impact
on the future financial results of the Company has not been determined.
Year 2000
The Year 2000 presents concerns for business and consumer computing. Aside from
the well-known problems with the use of certain 2-digit date formats as the year
changes from 1999 to 2000, the Year 2000 is a special case leap year, and dates
such as 9/9/99 were used by certain organizations for special functions. The
problem exists for many kinds of software and hardware, including mainframes,
mini-computers, PCs, and embedded systems.
Microsoft offers a broad range of information resources and software updates to
help customers plan and implement Year 2000 remediation programs. Current
information about the Company's products and business and technical issues is
available at the Microsoft Year 2000 Readiness Disclosure and Resource Center
web site (www.microsoft.com/year2000). Information on the web site will help
customers evaluate the impact of the Year 2000 on Microsoft products used in
their computing environments.
The Company is continuing to test its products and classify its tested products
into the following categories of compliance: "compliant," "compliant with minor
issues," and "not compliant." Most of the products tested are either
"compliant" or "compliant with minor issues," as defined. Microsoft's policy is
to make future and current versions of its core products Year 2000 "compliant,"
although the status of certain current versions will remain at "compliant with
minor issues." For non-compliant products, Microsoft is providing
recommendations as to how an organization may address possible Year 2000 issues
regarding that product. Microsoft is issuing software updates (at no additional
charge) for most, but not all, known issues. Not all products will be tested.
Information on the Company's web site is provided to customers for the sole
purpose of assisting in planning for the transition to the Year 2000. Such
information is the most currently available concerning the behavior of the
Company's products and is provided "as is" without warranty of any kind.
However, variability of definitions of "compliance" with the Year 2000 and of
different combinations of software, firmware, and hardware will likely lead to
lawsuits against the Company. The outcome of such lawsuits and the impact on
the Company are not estimable at this time.
The Year 2000 issue also affects the Company's internal systems, including
information technology (IT) and non-IT systems. Microsoft is assessing the
readiness of its systems for handling the Year 2000, and has started the
remediation and certification process. Contingency plans are being developed in
parallel with the testing and remediation efforts.
Microsoft is evaluating its third-party distribution and supply chain and
vendors to understand their ability to continue providing services and products
through the change to the year 2000. Microsoft is monitoring and working
directly with key vendors, product manufacturers, distributors, and direct
resellers to avoid any business interruptions in the year 2000. For critical
third parties with known issues, contingency plans will be developed.
The Company is also reviewing its facilities and infrastructure. Remediation
efforts are under way and certain contingency plans are in development.
________________________________________________________________________________
12
While Year 2000 issues present a potential risk to Microsoft's internal systems,
distribution and supply chain, and facilities, the Company is minimizing risk
with a worldwide effort. Microsoft is performing an extensive assessment and is
in the process of testing and remediating mission critical components. The
current plan is to have the majority of these components resolved by June 1999,
with the remaining components resolved by September 1999. Management currently
believes that all critical systems will be ready by the Year 2000 and that the
cost to address the issues is not material.
Resolving Year 2000 issues is a worldwide phenomenon that will likely absorb a
substantial portion of IT budgets and attention in the near term. Certain
industry analysts believe the Year 2000 issue will accelerate the trend toward
distributed PC-based systems from mainframe systems. Others believe a majority
of IT financial resources will be devoted to fixing older mainframe software in
lieu of funding purchases of PC software or transitions to systems based on
software such as that sold by Microsoft. The impact of the Year 2000 on future
Microsoft revenue is difficult to discern but is a risk to be considered in
evaluating future growth of the Company.
________________________________________________________________________________
13
Part II. Other Information
Item 1. Legal Proceedings
See notes to financial statements.
Item 2. Changes in Securities and Use of Proceeds
During the quarter, the Company issued an aggregate of 918,702 of its common
shares pursuant to a merger in exchange for the outstanding capital shares of
Compare Net, Inc. held by 16 shareholders. The shares were issued pursuant to
an exemption by reason of Section 4(2) of the Securities Act of 1933. These
sales were made without general solicitation or advertising. Each purchaser
represented that he, she, or it was an accredited investor with access to all
relevant information necessary. The Company has filed a Registration Statement
on Form S-3 covering the resale of such securities.
During the quarter, the Company issued an aggregate of 28,025,414 of its common
shares to a major institutional investor in satisfaction of outstanding
financial obligations of the Company, as described in the accompanying notes to
financial statements. The shares were issued pursuant to an exemption by reason
of Section 4(2) of the Securities Act of 1933. These sales were made without
general solicitation or advertising. The institutional investor is an accredited
investor with access to all relevant information necessary. The Company has
entered into an agreement that grants registration rights to the institutional
investor on Form S-3.
Reference is also made to the information on sales of put warrants described in
the accompanying notes to financial statements. All such transactions are exempt
from registration under Section 4(2) of the Securities Act of 1933. Each
transaction was privately negotiated and each offeree and purchaser was an
accredited investor/qualified institutional buyer. No public offering or public
solicitation was used by the registrant in the placement of these securities.
Item 4. Submission of Matters to a Vote of Security Holders
At a Special Meeting of Shareholders held on March 12, 1999, the following
proposal was adopted by the margin indicated:
To amend the Company's Articles of Incorporation to increase the authorized
common stock from 4,000,000,000 shares to 12,000,000,000 shares and halve the
par value of the common stock from $.000025 per share to $.0000125 per share
in order to accommodate the proposed two-for-one split of the Company's common
stock.
Shares voting:
For 2,191,343,759
Against 31,891,442
Abstain 4,577,616
Item 6. Exhibits and Reports on Form 8-K
(A) EXHIBITS
27. Financial Data Schedule
(B) REPORTS ON FORM 8-K
Microsoft filed no reports on Form 8-K during the quarter ended March 31,
1999.
Items 3 and 5 are not applicable and have been omitted.
________________________________________________________________________________
14
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Microsoft Corporation
Date: May 12, 1999 By: /s/ Gregory B. Maffei
----------------------------
Gregory B. Maffei,
Senior Vice President, Finance and
Administration; Chief Financial Officer
(Principal Financial and Accounting
Officer and Duly Authorized Officer)
________________________________________________________________________________
15
5
1,000,000
9-MOS
JUN-30-1999
MAR-31-1999
21,761
0
1,689
0
0
24,058
3,333
1,888
33,561
7,839
0
0
980
12,418
12,324
33,561
13,222
13,222
1,090
1,090
5,107
0
0
8,503
2,920
5,583
0
0
0
5,583
1.11
1.02
EPS primary and EPS diluted have been restated to reflect a two-for-one
stock split in March 1999. Prior Financial Data Schedules have not been
restated.
