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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 DECEMBER 31, 1994
[ ] 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: (206) 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 February 7, 1995 was 581,228,389.
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2
MICROSOFT CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 1994
INDEX
PART I. FINANCIAL INFORMATION
Page
----
Item 1. Financial Statements
a) Income Statements
for the Three and Six Months Ended December 31, 1994 and 1993. . . . 1
b) Balance Sheets
as of December 31, 1994 and June 30, 1994. . . . . . . . . . . . . . 2
c) Cash Flows Statements
for the Six Months Ended December 31, 1994 and 1993. . . . . . . . . 3
d) Notes to Financial Statements. . . . . . . . . . . . . . . . . . . . 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . . . . . . . . . . 6
PART II. OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . . . . . . 9
SIGNATURE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
3
Part I. Financial Information
ITEM 1. FINANCIAL STATEMENTS
MICROSOFT CORPORATION
Income Statements
(In millions, except earnings per share)(Unaudited)
- ------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
December 31 December 31
------------------ ------------------
1993 1994 1993 1994
------ ------ ------ ------
Net revenues $1,129 $1,482 $2,112 $2,729
------ ------ ------ ------
Costs and expenses:
Cost of revenues 185 222 344 408
Research and development 150 199 284 377
Sales and marketing 337 479 649 874
General and administrative 42 62 77 113
------ ------ ------ ------
Total costs and expenses 714 962 1,354 1,772
------ ------ ------ ------
Operating income 415 520 758 957
Interest income - net 25 42 48 78
Other expenses (2) (5) (6) (7)
------ ------ ------ ------
Income before income taxes 438 557 800 1,028
Provision for income taxes 149 184 272 339
------ ------ ------ ------
Net income $ 289 $ 373 $ 528 $ 689
====== ====== ====== ======
Earnings per share(1) $ 0.48 $ 0.60 $ 0.87 $ 1.10
====== ====== ====== ======
Weighted average shares outstanding(1) 608 625 607 624
====== ====== ====== ======
(1) Share and per share amounts for the three and six months ended December
31, 1993 have been restated to reflect a two-for-one stock split in May
1994.
See accompanying notes.
1
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MICROSOFT CORPORATION
Balance Sheets
(In millions)
- -----------------------------------------------------------------------------
June 30 Dec. 31
1994 1994(1)
------- -------
ASSETS
Current assets:
Cash and short-term investments $3,614 $3,839
Accounts receivable - net 475 591
Inventories 102 117
Other 121 149
------ ------
Total current assets 4,312 4,696
Property, plant, and equipment - net 930 977
Other assets 121 288
------ ------
Total assets $5,363 $5,961
====== ======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 324 $ 431
Accrued compensation 96 110
Income taxes payable 305 364
Other 188 191
------ ------
Total current liabilties 913 1,096
------ ------
Minority interest -- 125
------ ------
Put warrants -- 297
------ ------
Stockholders' equity:
Common stock and paid-in capital--
shares authorized 2,000;
shares outstanding 581 1,500 1,699
Retained earnings 2,950 2,744
------ ------
Total stockholders' equity 4,450 4,443
------ ------
Total liabilities and stockholders' equity $5,363 $5,961
====== ======
(1) Unaudited
See accompanying notes.
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MICROSOFT CORPORATION
Cash Flows Statements
(In millions)(Unaudited)
- ---------------------------------------------------------------------
Six Months Ended
December 31
1993 1994
------ ------
CASH FLOWS FROM OPERATIONS
Net income $ 528 $ 689
Depreciation and amortization 88 133
Current liabilities 187 194
Accounts receivable (130) (134)
Inventories (5) (17)
Other current assets (3) (30)
------ ------
Net cash from operations 665 835
------ ------
CASH FLOWS FROM FINANCING
Common stock issued 90 140
Common stock repurchased (164) (560)
Stock option income tax benefits 64 78
------ ------
Net cash from financing (10) (342)
------ ------
CASH FLOWS USED FOR INVESTMENTS
Additions to property, plant, and equipment (122) (170)
Other assets (19) (90)
Short-term investments (568) (785)
------ ------
Net cash used for investments (709) (1,045)
------ ------
Net change in cash and equivalents (54) (552)
Effect of exchange rates on cash
and equivalents (8) (8)
Cash and equivalents, beginning of period 1,013 1,477
------ ------
Cash and equivalents, end of period 951 917
Short-term investments, end of period 1,845 2,922
------ ------
Cash and short-term investments,
end of period $2,796 $3,839
====== ======
See accompanying notes.
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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 and cash flows include all adjustments (consisting
only of normal recurring items) necessary for their fair presentation. 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 the
Management's Discussion and Analysis and financial statements and notes thereto
included in the Microsoft Corporation 1994 Annual Report.
EARNINGS PER SHARE
Earnings per share is computed on the basis of the weighted average number of
common shares outstanding plus the effect of outstanding stock options, using
the treasury stock method.
STOCK SPLIT
Effective May 6, 1994, outstanding shares of common stock were split
two-for-one. All fiscal 1994 share and per share amounts have been restated
for the stock split.
PUT WARRANTS
In connection with the Company's stock repurchase program, put warrants
were sold to independent third parties during the first two quarters of fiscal
1995. The put warrants entitle the holders to sell shares of Microsoft common
stock to the Company at specified prices. On December 31, 1994, 6.4 million
warrants were outstanding, with prices ranging from $49.49 to $59.04 per share.
The warrants expire at various dates between February 1995 and May 1996, are
exercisable only at maturity, and are settleable in cash at the Company's
option. The maximum potential repurchase obligation of $297 million has been
reclassified from stockholders' equity to put warrants as of December 31, 1994.
There was no impact on earnings per share for the first two quarters of fiscal
1995.
AGREEMENT TO MERGE
On October 13, 1994, Microsoft announced its agreement to merge with Intuit
Inc., a leading developer of personal finance, tax preparation, and small
business accounting software. Under the terms of the reorganization agreement,
Microsoft will exchange approximately 27 million shares of its common stock for
all of the outstanding shares of Intuit. The transaction is anticipated to be
accounted for as a pooling of interests. The agreement is subject to approval
by the shareholders of Intuit and satisfaction of regulatory requirements.
MICROSOFT ONLINE SERVICES PARTNERSHIP
During November 1994, a wholly owned subsidiary of Tele-Communications, Inc.
(TCI) purchased a 20% minority interest in the newly formed Microsoft Online
Services Partnership. TCI contributed $125 million of TCI common stock and
Microsoft contributed the business assets of its online service, which is in
development. Microsoft owns 80% of the entity, whose operations have not been
material to the financial results of Microsoft.
CONTINGENCIES
On July 15, 1994, Microsoft entered into an undertaking with the Commission of
the European Communities ("European Commission") resolving a complaint
submitted by Novell, Inc. claiming that certain practices of Microsoft violated
Articles 85 and 86 of the Treaty of Rome. The undertaking is effective
immediately, requires no further approval, and closes the investigation of
Novell's complaint by the European Commission's Directorate-General for
Competition. In the undertaking, which invloves no admission of wrongdoing on
Microsoft's part, Microsoft agreed to make certain changes in its OEM
licensing practices. Microsoft also agreed to employ a uniform duration in its
nondisclosure agreements for precommerical versions of cetain operating system
products, and clarified the rights and responsibilities of those signing such
nondisclousre agreements. The European Commission has the right to monitor
Microsoft's compliance during the 6-1/2 year term of the settlement agreement.
On July 15, 1994, Microsoft and the U.S. Department of Justice ("DOJ") entered
into a consent decree resolving the DOJ's non-public investigation of Microsoft.
The consent decree contained the same provisions as the undertaking between
Microsoft and the European Commission. To become final, the consent decree
must be approved by the U.S. District Court for the District of Columbia. The
Court has held three status conferences as well as a hearing on January 20,
1995. The Court is currently considering submissions by the DOJ, Microsoft,
and a third party that has requested the opportunity to intervene.
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7
Microsoft does not expect the undertaking with the European Commission or the
consent decree with the DOJ to affect its OEM revenues materially.
On March 17, 1988, Apple Computer, Inc. (Apple) brought suit against Microsoft
and Hewlett-Packard Company for alleged copyright infringement in the U.S.
District Court, Northern District of California. The complaint included
allegations that the visual displays of Microsoft Windows version 2.03 (and
Windows version 3.0, which was added to the complaint later) infringed Apple's
copyrights and exceeded the scope of a 1985 Settlement Agreement between
Microsoft and Apple. The complaint sought to enjoin Microsoft from marketing
Microsoft Windows versions 2.03 and 3.0 or any derivative work based on Windows
2.03 or 3.0 and from otherwise infringing Apple's copyrights and sought damages
resulting from the alleged infringement.
Microsoft answered the complaint, raising affirmative defenses including its
claim that the 1985 Settlement Agreement entitled it to use the visual
displays in question, denying Apple's allegations that the visual displays
in Microsoft Windows version 2.03 and 3.0 infringe any protectible right of
Apple, and asserting counterclaims.
On August 24, 1993, the U.S. District Court entered final judgment
dismissing all of Apple's claims. Apple appealed a number of the U.S. District
Court's decisions in the case to the Ninth Circuit Court of Appeals, which on
September 19, 1994 issued a decision affirming the rulings of the U.S. District
Court. On December 19, 1994, Apple filed a petition with the U.S. Supreme
Court to grant review of the Ninth Circuit Court's decision.
On July 30, 1993 Wang Laboratories, Inc. (Wang) filed suit in U.S. District
Court for the District of Massachusetts against Microsoft and Watermark
Software, Inc., alleging that unspecified Microsoft products infringe
two patents owned by Wang concerning object management and the handling of
compound documents (United States Patents 5,206,951 issued on April 27, 1993,
and 5,129,061 issued on July 7, 1992, respectively). The suit also alleges
that Microsoft induced and continues to induce others, including Watermark
Software, Inc., to infringe the Wang patents. Microsoft's OLE technology
appears to be the subject of Wang's allegations against Microsoft. The
complaint seeks a determination that Microsoft's alleged infringement is
willful, an award of treble damages, an award of attorneys' fees, and to
preliminarily and permanently enjoin Microsoft from continuing the alleged
infringement. In its answer Microsoft denied that any of its products infringe
the Wang patents and asked the Court for a declaratory judgment that those
patents are invalid and unenforceable for failing to meet patent law
requirements. The suit is currently in the early stages of discovery.
Although there is no assurance that these matters will be resolved favorably
and that Microsoft's future financial statements will not be adversely
affected, Microsoft currently believes that resolution of the undertaking,
consent decree, and the lawsuits will not have material adverse effects on its
financial condition or results of operations.
5
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
OVERVIEW
Microsoft Corporation develops, manufactures, markets, licenses, and supports a
wide range of software products, including operating systems for personal
computers (PCs), workstations, and servers; business and consumer programs for
productivity, reference, education, and entertainment; and software development
tools. Microsoft also markets personal computer books and hardware; and is
engaged in the research and potential development of advanced technology
software products.
REVENUES
Revenues for the second quarter of fiscal 1995 increased 31% over revenues for
the second quarter of fiscal 1994, while revenues for the first half of 1995
grew 29% compared to the prior year.
Software license volume (as opposed to price) 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 sales mix from retail
packaged products to licensing programs, from new products to product upgrades,
and from stand-alone desktop applications programs to the Microsoft(#) Office
integrated suite. Average revenue per license from OEM licenses and corporate
license programs (such as Microsoft Select) is lower than average revenue per
license from retail versions. Likewise, product upgrades have lower prices than
new products. The price of Microsoft Office is less than the sum of the prices
for the individual application programs included in this product when such
programs are sold separately.
PRODUCT GROUPS
Systems product group revenues are primarily from licenses of personal
operating systems and business systems with client-server architectures.
Systems revenues were $519 million in the second quarter of 1995, compared to
$369 million recorded in the same period of 1994, an increase of 41%. Systems
revenues were $963 million in the first half of 1995 compared to $724 million
in the first half of 1994. Revenues generated by both Microsoft MS-DOS(#) and
Microsoft Windows(#) operating systems increased from the prior year, primarily
through the original equipment manufacturer channel. During the second quarter
of 1995, more than 80% of Windows units were licensed through the OEM channel.
Revenues from the Company's business system division's BackOffice line of
products also increased, due to greater corporate demand for Windows NT(#)
Server and Windows NT Workstation.
Applications product group revenues include primarily licenses of desktop
productivity, consumer, and developer programs. Applications revenues were
$889 million in the second quarter of 1995, increasing 26% from $707 million in
the second quarter of 1994. For the first two quarters of 1995, applications
revenues were $1.64 billion, compared to $1.28 billion in 1994. Increases in
applications revenues were led by sales of Microsoft Office. Microsoft Office
Standard includes Microsoft Excel, Microsoft Word, a Microsoft Mail license,
and the Microsoft PowerPoint(#) presentation graphics program. Microsoft Office
Professional for Windows includes all of the above plus the Microsoft Access(#)
database management program.
Microsoft Home, a broad range of products in the Company's consumer
applications group, continued to show strong growth, particularly during the
cyclically higher Christmas season. New titles and new versions of existing
titles both contributed to the growth.
The hardware product group's principal products are the Microsoft Mouse and
BallPoint(#) mouse pointing devices. Hardware revenues were $74 million and $53
million in the second quarters of 1995 and 1994. On a year to date basis,
hardware revenues increased 18% to $123 million from $104 million.
SALES CHANNELS
The Company has four major channels of distribution: OEM; U.S. and Canada;
Europe; and Other International. OEM channel revenues are license fees from
original equipment manufacturers. Sales in the retail channels are primarily
to distributors and resellers.
Microsoft Select was introduced in 1993 and continues to grow in popularity.
Select is a corporate license program under which large accounts download a
contracted number of copies of specified software products. Average revenue
per license under Select is lower than average revenue per retail copy of the
same product shipped through the retail channels, reflecting lower costs of
distribution.
6
9
OEM revenues (primarily personal operating systems) grew 44% to $385
million from the $268 million recorded in the comparable quarter of the prior
year. In the first half of 1995, OEM revenues were $733 million, up 40% from
$523 million in the first half of 1994. MS-DOS continues to be preinstalled on
many PCs sold by original equipment manufacturers. In addition, many major
OEMs are also preinstalling the Microsoft Windows operating system on PCs.
Higher levels of PC shipments have led to increased revenues through the OEM
channel.
Revenues in the U.S. and Canada were $491 million in the second quarter of 1995
compared to $423 million in 1994, an increase of 16%. The latest version of
Microsoft Office for Windows was introduced in the U.S. during the comparable
quarter of the prior year. On a year to date basis, U.S. and Canada channel
revenues increased 22%, to $914 million in 1995 from $751 million in 1994.
Revenues in Europe were $399 million in the second quarter of 1995 compared to
$324 million the prior year. European revenues for the first two quarters of
1995 were $688 million, compared to $598 in 1994. Rates of growth for the
European channel have been lower than other retail channels of distribution due
to general economic slowness and a more dramatic shift to corporate licensing
in Europe.
Other International channel revenues showed strong growth, increasing to $207
million in the second quarter of 1995 from $114 million in the second quarter
of 1994. Revenues increased 64% to $394 million for the first half of 1995,
compared to $240 million the prior year. Growth rates continue to be strong
due to customer acceptance of newly localized products and early entrance into
emerging markets.
The Company's operating results are affected by foreign exchange rates. Since
much of the Company's international manufacturing costs and operating expenses
are also incurred in local currencies, the relative translation impact of
exchange rates on net income is less than on revenues.
COST OF REVENUES, OPERATING EXPENSES, AND INCOME TAXES
Cost of revenues as a percentage of revenues was 15.0% in the second quarter of
1995, compared to 16.4% in the second quarter of 1994. Contributing to the
decrease were lower disk prices from vendors and a shift to more revenues from
OEM and corporate license programs, offset by greater sales of lower-margin
Microsoft Office and upgrade products. While license programs carry lower
prices per license than retail versions shipped though the retail channels,
there is little cost of revenues associated with such programs.
Research and development expenses increased 33% to $199 million, or 13.4% of
revenues in the second quarter of 1995 from $150 million, or 13.3% of revenues
in the corresponding quarter of 1994. The increases in research and
development expenses in both the second quarter and first half of 1995 resulted
primarily from planned hiring of software developers and higher levels of
third-party development costs.
Sales and marketing expenses increased 42% to $479 million from $337 million in
the comparable quarter. As a percentage of revenues, sales and marketing
expenses were 32.3% and 29.9% in the respective second quarters of 1995 and
1994. The increases in sales and marketing expenses in both the second quarter
and first half of 1995 were due to increased personnel related expenses,
product support costs, Microsoft brand advertising, and marketing costs.
General and administrative expenses were 4.2% of revenues in the second quarter
of 1995 and 3.7% of revenues in the second quarter of 1994. Increases in both
the second quarter and first half of 1995 were due to higher legal costs and
growth in the systems and people necessary to support overall increases in the
scope of Microsoft's operations.
Net interest income increased as a result of a larger investment portfolio
generated by cash from operations combined with higher interest rates.
The effective income tax rate was 33% in the second quarter and first half of
1995, compared to 34% in the same periods of 1994.
NET INCOME
Net income for the second quarter of 1995 was $373 million. Net income as a
percentage of revenues was 25.2% in the second quarter of 1995, compared with
25.6% in the second quarter of 1994. The slight decrease was the result of
higher levels of operating expenses offset by the lower cost of revenues
and higher interest income percentages.
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10
FINANCIAL CONDITION
The Company's cash and short-term investment portfolio totaled $3.84 billion at
December 31, 1994 and represented 64% of total assets. The portfolio is
diversified among security types, industries, and individual issuers. The
Company's investments are liquid and primarily investment grade. The
portfolio, while invested predominantly in U.S. dollar denominated securities,
also includes foreign currency positions in anticipation of local currency
funding needs. The Company's portfolio is invested in short-term securities to
minimize interest rate risk and to facilitate rapid deployment in the event of
immediate cash needs.
Microsoft has no material long-term debt. The Company has available $70
million of standby multicurrency lines of credit. These lines support foreign
currency hedging and international cash management. Stockholders' equity at
December 31, 1994 exceeded $4 billion.
Cash generated from operations has been sufficient to fund the Company's
investment in research and development activities and facilities expansion. As
the Company grows, investments will continue in research and development in
existing and advanced areas of technology. The Company's cash will be used to
acquire technology or to fund strategic ventures. Additions to property,
plant, and equipment are expected to continue, including new facilities and
computer systems for research and development; sales and marketing; product
support; and administrative staff. On December 31, 1994, commitments related
to the construction of new buildings approximated $235 million.
The exercise of stock options by employees provides additional cash. These
proceeds have funded the Company's open market stock repurchase program through
which Microsoft provides shares for stock option and stock purchase plans.
This practice is continuing in 1995. Additionally, the Company enhanced its
stock repurchase program by selling put warrants during the first half of 1995.
See Notes to Financial Statements.
Management believes existing cash and short-term investments together with
funds generated from operations should be sufficient to meet the Company's
operating requirements for the next 12 months. The Company's cash and
short-term investments are also managed so as to be available for such other
strategic investment opportunities or other potential large-scale cash needs as
might arise in pursuit of the Company's long-term strategies. Additionally, on
Ocotber 28, 1994, Microsoft shareholders authorized the Company to issue up to
100 million shares of preferred stock, which may be used by the Company for any
proper corporate purpose.
8
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Part II. Other Information
ITEM 1. LEGAL PROCEEDINGS
On July 15, 1994, Microsoft and the U. S. Department of Justice (DOJ) entered
into a consent decree resolving the DOJ's nonpublic investigation of Microsoft.
To become final, the consent decree must be approved by the U.S. District Court
for the District of Columbia. The Court has held three status conferences as
well as a hearing on January 20, 1995. Under the Tunney Act, which defines the
scope of the Court's review of a consent decree, the Court must determine
whether the relief provided in the consent decree is adequate to remedy the
antitrust violations alleged in the complaint. The Court may either approve or
not approve the consent decree, but cannot require Microsoft or the DOJ to
alter any of its terms. The Company is also currently involved in litigation
with Apple Computer, Inc., and Wang Laboratories, Inc. See Notes to
Financial Statements.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
11. Computation of Earnings Per Share is on page 11.
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the quarter ended
December 31, 1994.
ITEMS 2, 3, 4, AND 5 ARE NOT APPLICABLE AND HAVE BEEN OMITTED.
9
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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: February 14, 1995 By: /s/ Michael W. Brown
--------------------------------
Michael W. Brown,
Vice President, Finance;
Chief Financial Officer
(Principal Financial and
Accounting Officer and Duly
Authorized Officer)
10
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EXHIBIT 11.
MICROSOFT CORPORATION
Computation of Earnings Per Share
(In millions, exzcept earnings per share)
- -------------------------------------------------------------------------------
Three Months Ended Six Months Ended
December 31 December 31
------------------ ----------------
1993 1994 1993 1994
----- ----- ----- -----
Weighted average number of common shares
outstanding 568 581 568 581
Common stock equivalents from outstanding
stock options 40 44 40 43
----- ----- ----- -----
Average common and common stock equivalents
outstanding 608 625 608 624
===== ===== ===== =====
Net Income $ 289 $ 373 $ 528 $ 689
===== ===== ===== =====
Earnings per share(1)(2) $0.48 $0.60 $0.87 $1.10
===== ===== ===== =====
(1) Share and per share amounts for the three and six months ended
December 31, 1993 have been restated to reflect a two-for-one stock split
in May 1994.
(2) Fully diluted earnings per share have not been presented because the
effects are not material.
11
5
1,000,000
6-MOS
JUN-30-1995
JUL-01-1994
DEC-31-1994
3,839
0
706
115
117
4,696
1,577
600
5,961
1,096
0
1,699
0
0
2,744
5,961
2,729
2,729
408
1,339
7
25
0
1,028
339
689
0
0
0
689
1.10
1.10
