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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, 1999
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From _____ to ____
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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 January
31, 2000 was 5,204,853,333.
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MICROSOFT CORPORATION
FORM 10-Q
For the Quarter Ended December 31, 1999
INDEX
Part I. Financial Information
Item 1. Financial Statements Page
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a) Income Statements
for the Three and Six Months Ended December 31, 1998 and 1999.... 1
b) Balance Sheets
as of June 30, 1999 and December 31, 1999........................ 2
c) Cash Flows Statements
for the Six Months Ended December 31, 1998 and 1999.............. 3
d) Stockholders' Equity Statements
for the Three and Six Months Ended December 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................................ 10
Part II. Other Information
Item 1. Legal Proceedings.................................................. 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)
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Three Months Ended Six Months Ended
Dec. 31 Dec. 31
1998 1999 1998 1999
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Revenue $5,195 $6,112 $9,388 $11,496
Operating expenses:
Cost of revenue 788 756 1,437 1,468
Research and development 715 911 1,366 1,745
Sales and marketing 794 1,027 1,482 1,930
General and administrative 149 506 248 649
Other expenses (income) 35 (6) 59 19
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Total operating expenses 2,481 3,194 4,592 5,811
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Operating income 2,714 2,918 4,796 5,685
Investment income 337 773 598 1,170
Gains on sales 0 0 160 156
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Income before income taxes 3,051 3,691 5,554 7,011
Provision for income taxes 1,068 1,255 1,888 2,384
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Net income $1,983 $2,436 $3,666 $ 4,627
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Earnings per share (1):
Basic $ 0.40 $ 0.47 $ 0.73 $ 0.90
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Diluted $ 0.36 $ 0.44 $ 0.67 $ 0.84
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(1) Earnings per share amounts for the three and six months ended December 31,
1998 have been restated to reflect a two-for-one stock split in March 1999.
See accompanying notes.
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1
MICROSOFT CORPORATION
Balance Sheets
(In millions)
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June 30 Dec. 31
1999 1999 (1)
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Assets
Current assets:
Cash and short-term investments $17,236 $17,843
Accounts receivable 2,245 3,284
Other 752 893
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Total current assets 20,233 22,020
Property and equipment 1,611 1,739
Equity and other investments 14,372 19,801
Other assets 940 1,533
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Total assets $37,156 $45,093
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Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 874 $ 1,233
Accrued compensation 396 533
Income taxes payable 1,607 2,103
Unearned revenue 4,239 4,259
Other 1,602 2,376
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Total current liabilities 8,718 10,504
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Commitments and contingencies
Stockholders' equity:
Convertible preferred stock -
shares authorized 100; outstanding 13 and 0 980 0
Common stock and paid-in capital -
shares authorized 12,000; outstanding 5,020 and 5,177 13,844 18,878
Retained earnings 13,614 15,711
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Total stockholders' equity 28,438 34,589
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Total liabilities and stockholders' equity $37,156 $45,093
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(1) Unaudited
See accompanying notes.
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2
MICROSOFT CORPORATION
Cash Flows Statements
(In millions)(Unaudited)
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Six Months Ended
Dec. 31
1998 1999
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Operations
Net income $ 3,666 $ 4,627
Depreciation and amortization 356 765
Gains on sales (160) (156)
Unearned revenue 2,371 2,638
Recognition of unearned revenue from prior periods (1,707) (2,618)
Other current liabilities 719 61
Accounts receivable (486) (1,030)
Other current assets (24) (149)
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Net cash from operations 4,735 4,138
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Financing
Common stock issued 614 913
Common stock repurchased (772) (4,852)
Put warrant proceeds 355 472
Preferred stock dividends (14) (13)
Stock option income tax benefits 1,218 2,636
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Net cash from (used for) financing 1,401 (844)
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Investing
Additions to property and equipment (241) (371)
Cash proceeds from sale of Softimage, Inc. 79 0
Purchases of investments (10,220) (18,759)
Maturities of investments 1,199 950
Sales of investments 5,263 14,923
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Net cash used for investing (3,920) (3,257)
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Net change in cash and equivalents 2,216 37
Effect of exchange rates on cash and equivalents 58 20
Cash and equivalents, beginning of period 3,839 4,975
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Cash and equivalents, end of period 6,113 5,032
Short-term investments, end of period 13,124 12,811
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Cash and short-term investments, end of period $19,237 $17,843
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See accompanying notes.
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3
MICROSOFT CORPORATION
Stockholders' Equity Statements
(In millions)(Unaudited)
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Three Months Ended Six Months Ended
Dec. 31 Dec. 31
1998 1999 1998 1999
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Convertible preferred stock
Balance, beginning of period $ 980 $ 980 $ 980 $ 980
Conversion of preferred to common stock 0 (980) 0 (980)
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Balance, end of period 980 0 980 0
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Common stock and paid-in capital
Balance, beginning of period 9,161 15,878 8,025 13,844
Common stock issued 536 1,525 870 2,092
Common stock repurchased (11) (128) (25) (166)
Proceeds from sale of put warrants 130 182 355 472
Stock option income tax benefits 627 1,421 1,218 2,636
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Balance, end of period 10,443 18,878 10,443 18,878
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Retained earnings
Balance, beginning of period 8,983 14,482 7,622 13,614
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Net income 1,983 2,436 3,666 4,627
Net unrealized investments gains 390 2,485 540 2,141
Translation adjustments and other 63 4 106 28
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Comprehensive income 2,436 4,925 4,312 6,796
Preferred stock dividends (7) (6) (14) (13)
Common stock repurchased (257) (3,690) (765) (4,686)
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Balance, end of period 11,155 15,711 11,155 15,711
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Total stockholders' equity $22,578 $34,589 $22,578 $34,589
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See accompanying notes.
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4
MICROSOFT CORPORATION
Notes to Financial Statements
(Unaudited)
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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 1999 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)
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Three Months Ended Six Months Ended
Dec. 31 Dec. 31
1998 1999 1998 1999
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Net income (A) $1,983 $2,436 $3,666 $4,627
Preferred stock dividends (7) (6) (14) (13)
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Net income available for common shareholders (B) $1,976 $2,430 $3,652 $4,614
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Average outstanding shares of common stock (C) 4,998 5,163 4,978 5,146
Dilutive effect of:
Common stock under structured repurchases 22 0 19 0
Preferred stock 20 12 22 13
Employee stock options 420 363 428 374
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Common stock and common stock equivalents (D) 5,460 5,538 5,447 5,533
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Earnings per share:
Basic (B/C) $ 0.40 $ 0.47 $ 0.73 $ 0.90
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Diluted (A/D) $ 0.36 $ 0.44 $ 0.67 $ 0.84
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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 products over a period of
time. These elements include browser technologies and technical support.
Consequently, Microsoft's earned revenue reflects the recognition of the fair
value of these elements over the product's life cycle. The percentage of revenue
recognized ratably ranges from approximately 15% to 25% of Windows desktop
operating systems and approximately 10% to 20% of desktop applications,
depending on the terms and conditions of the license and prices of the elements.
Product life cycles are currently estimated at three years for Windows operating
systems and 18 months for desktop applications. The Company also sells
subscriptions to certain products via maintenance and certain organization
license agreements. At December 31, 1999, unearned revenue was $4.26 billion.
Windows Platforms products unearned revenue was $2.40 billion and unearned
revenue associated with Productivity Applications and Developer products totaled
$1.70 billion. Unearned revenue for other miscellaneous programs totaled $161
million at December 31, 1999.
Stockholders' Equity
During the first half of fiscal 2000, the Company repurchased 54.7 million
shares of Microsoft common stock in the open market. In January 2000, the
Company announced the termination of its stock buyback program.
To enhance its stock repurchase program, Microsoft sold 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.
On December 31, 1999, 163 million warrants were outstanding with strike prices
ranging from $69 to $78 per share. The put warrants expire between June 2000 and
December 2002. The outstanding put warrants permit a net-share settlement at the
Company's option and do not result in a put warrant liability on the balance
sheet.
During 1996, Microsoft issued 12.5 million shares of 2.75% convertible
exchangeable principal-protected preferred stock. Net proceeds of $980 million
were used to repurchase common shares. The Company's convertible preferred stock
matured on December 15, 1999. Each preferred share was converted into 1.1273
common shares.
Operational Transactions
In November 1999, Expedia, Inc. completed an initial public offering of its
common stock. Expedia, which is majority-owned by Microsoft, is a leading
provider of branded online travel services for leisure and small business
travelers. Expedia's financial results and financial condition are consolidated
with the operations of Microsoft.
In September 1999, the Company sold the entertainment city guide portion of
MSN(TM) Sidewalk(R) to Ticketmaster Online-CitySearch, Inc. (TMCS) for a
combination of TMCS stock and warrants with a value of $223 million. The
transaction also included a distribution agreement. Microsoft recognized a gain
of $156 million on the sale and will recognize amounts related to the
distribution arrangement over the term of the agreement.
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 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.
Subsequent Events
In January 2000, the Company merged with Visio Corporation in a transaction that
will be accounted for as a pooling of interests. Microsoft issued 14 million
shares in exchange for the outstanding stock of Visio.
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6
Contingencies
On October 7, 1997, Sun Microsystems, Inc. ("Sun") 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 browser technology 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 (SDK) for Java 2.0. Microsoft has taken steps to fully comply
with the order.
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 Court of
Appeals on December 16, 1998. Microsoft complied with the ruling and did not
seek 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 July 23,
1999 the Court also granted Microsoft's motion to increase the bond on the
preliminary injunction from $15 million to $35 million.
On January 22, 1999, Microsoft and Sun filed a series of summary judgment
motions regarding the interpretation of the contract and other issues. On May
20, 1999, the Court issued tentative rulings on three of the motions. In the
preliminary rulings, the Court (1) granted Sun's motion for summary judgment
that prior versions of Internet Explorer 4.0, Windows 98, Windows NT, Visual J++
(R) 6.0 development system, and the SDK for Java infringe Sun's copyrights,
because they contain Sun's program code but do not pass Sun's compatibility
tests and, therefore, Microsoft's use of Sun's technology is outside the scope
of the Agreement and unlicensed; (2) granted Microsoft's motion that the
Agreement authorizes Microsoft to distribute independently developed Java
Technology that is not subject to the compatibility obligations in the
Agreement; and (3) denied Sun's motion for summary judgment on the meaning of
certain provisions of the Agreement, tentatively adopting Microsoft's
interpretation that Sun is required to deliver certain new Java Technology,
called "Supplemental Java Classes," in working order on Microsoft's then
existing and commercially distributed virtual machine. On June 24, 1999, the
Court heard oral argument on the three tentative rulings. No final orders have
been issued.
On August 23,1999 the 9th Circuit Court of Appeals vacated the November 1998
preliminary injunction and remanded the case to the district Court for further
proceedings. Sun immediately filed two motions to reinstate and expand the scope
of the earlier injunction on the basis of copyright infringement and unfair
competition. Oral argument on these motions was held on October 16, 1999. On
January 25, 2000, the Court issued rulings on the two motions, denying Sun's
motion to reinstate the preliminary injunction on the basis of copyright
infringement and granting, in part, Sun's motion to reinstate the preliminary
injunction based on unfair competition. Microsoft is in compliance with the
terms of the partially reinstated preliminary injunction and will not need to
undertake any further action to comply with the terms of the injunction. No
other hearing or trial dates have been 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
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7
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 and ended with closing arguments on September 21, 1999. The
Court will first rule on factual issues, and will then rule on legal conclusion
On November 5, 1999, Judge Jackson issued his Findings of Fact. The Conclusions
of Law in the case are not expected until sometime in 2000. The judge also
directed the parties to participate in a mediation process, which is ongoing.
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.
A number of antitrust class action lawsuits have been initiated against
Microsoft. Microsoft believes the claims are without merit and will vigorously
defend the cases.
The Securities and Exchange Commission is conducting a non-public investigation
into the Company's accounting reserve practices. 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.
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8
Segment Information
(In millions)
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Productivity
Windows Applications Consumer Reconciling
Three Months Ended Dec. 31 Platforms and Developer and Other Amounts Consolidated
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1998
Revenue $2,271 $2,277 $587 $ 60 $5,195
Operating income (loss) 1,538 1,392 (201) (15) 2,714
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1999
Revenue $2,412 $2,624 $721 $355 $6,112
Operating income (loss) 1,584 1,376 (300) 258 2,918
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Productivity
Windows Applications Consumer Reconciling
Six Months Ended Dec. 31 Platforms and Developer and Other Amounts Consolidated
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1998
Revenue $4,315 $4,095 $1,029 $(51) $ 9,388
Operating income (loss) 2,944 2,471 (415) (204) 4,796
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1999
Revenue $4,609 $5,054 $1,382 $451 $11,496
Operating income (loss) 3,068 2,796 (398) 219 5,685
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The Company's organizational structure and fundamental approach to business
reflect the needs of its customers. As such, Microsoft has three major segments:
Windows Platforms; Productivity Applications and Developer; and Consumer and
Other. Windows Platforms includes the Business and Enterprise Division, which is
primarily responsible for developing and marketing Windows NT and Windows 2000.
Windows Platforms also includes the Consumer Windows Division, which develops
and markets Windows 98 and Windows 95. Productivity Applications and Developer
includes the Business Productivity Division, which is responsible for developing
and marketing desktop applications, server applications, and developer tools.
Consumer and Other products and services include primarily learning,
entertainment, and PC input device products; WebTV and PC online access; and
portal and vertical properties and e-commerce platforms. Assets of the segment
groups are not relevant for management of the businesses nor for disclosure.
The Company's financial reporting systems present various data for management to
run the business, including profit and loss (P&L) statements prepared on a basis
not consistent with generally accepted accounting principles. Reconciling items
include certain elements of unearned revenue, the treatment of certain channel
inventory amounts and estimates, and revenue from product support, consulting,
and training and certification of system integrators. Additionally, the internal
P&Ls use accelerated methods of depreciation and amortization. In fiscal 2000,
the Company's internal P&Ls included the Black-Scholes value of employee stock
option grants, amortized over the remaining months of the fiscal year of the
grant. Prior year disclosures have been restated for consistent presentation.
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9
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 for a multitude of computing devices. Microsoft software
includes 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 network of Internet products and
services and alliances with companies involved with broadband access and various
forms of digital interactivity. Microsoft also licenses consumer software
programs; sells PC input devices; trains and certifies system integrators; and
researches and develops advanced technologies for future software products.
Revenue
Revenue of $6.11 billion in the December quarter of fiscal 2000 increased 18%
over the second quarter of fiscal 1999. The revenue growth reflected strong
licensing of Microsoft(R) Office 2000. Partially offsetting this growth was
moderate growth for Windows(R) operating systems, due to soft corporate demand
for PCs and software combined with the expected slowness of demand for Windows
NT(R) Server and Windows NT Workstation in anticipation of the launch of Windows
2000. On a year to date basis, revenue in the first half of fiscal 2000 totaled
$11.50 billion, an increase of 22% over the first two quarters of fiscal 1999.
Software license volume increases have been the principal factor in the
Company'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 desktop applications 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 Microsoft Windows, Microsoft Office, maintenance,
and other subscription models. See accompanying notes to financial statements.
Business Divisions
Microsoft has three major segments: Productivity Applications and Developer;
Windows Platforms; and Consumer and Other.
Productivity Applications and Developer products include desktop applications
such as Microsoft Office, server applications such as Microsoft Exchange Server
and Microsoft SQL Server(TM), and software developer tools. Revenue increased
28% to $2.80 billion in the December quarter. For the first half of fiscal 2000,
revenue of $5.25 billion grew 34% over the first half of fiscal 1999. Revenue
from Microsoft Office integrated suites, including the Premium, Professional,
Small Business, and Standard Editions was very strong, reflecting healthy demand
for Microsoft Office 2000. Revenue included the recognition of $64 million in
the second quarter and $150 million in the first quarter of previously unearned
revenue, due to fulfillment of the Microsoft Office 2000 Technology Guarantee.
Microsoft SQL Server 7.0 revenue continued to be robust. Revenue from Microsoft
Exchange Server and software developer tools was steady.
Windows Platforms products include primarily Windows 98, Windows NT Workstation,
and Windows NT Server. Revenue of $2.44 billion in the second quarter
represented growth of 6% over the prior year. Windows-based desktop operating
systems revenue grew slightly. Units licensed through the PC OEM channel
reflected slower growth of corporate PC purchases. Additionally, consumer PC
purchases through traditional retail channels were moderate and revenue from
retail versions of Windows 98 decreased. This decrease reflected the strong
comparable quarter of the prior year which included significant revenue from
Windows 98 after its launch in June 1998. Windows NT Workstation and Windows NT
Server revenue growth slowed, reflecting customer anticipation of the next
version of the operating system, Windows 2000. On a year to date basis, Windows
Platforms revenue of $4.69 billion grew 11% over the prior year. First quarter
OEM revenue of Windows was relatively strong, particularly for Windows NT
Workstation. Revenue from retail packaged product versions of Windows 98
decreased in the first quarter, reflecting the strong comparable quarter of the
prior year which included significant revenue from Windows 98 after its launch
in June 1998. Windows NT Server revenue growth was robust during the first
quarter.
Consumer and Other products include learning and entertainment software; PC
input devices; training and certification fees; consulting; and online services
such as Expedia. Revenue in the December quarter was $872
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10
million, up 23% from the comparable quarter of fiscal 1999. Consumer and Other
revenue of $1.56 billion grew 26% over the first half of the prior year.
Learning and entertainment software posted superb growth, reflecting strong
consumer Holiday demand. Hardware product revenue grew moderately. Online
advertising and access revenue rose substantially.
Distribution 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 via these channels are primarily to and through
distributors and resellers.
OEM second quarter revenue of $1.87 billion represented an increase of 4% over
the comparable quarter of fiscal 1999. There were several reasons for the
relatively low growth rate. The second quarter of fiscal 1999 was an unusually
high-growth quarter for OEM revenue, having grown 48% over the comparable
quarter of fiscal 1998. PC shipment growth was moderate in the December quarter
of fiscal 2000, with particular slowness in corporate PC demand. Average revenue
per license declined slightly, due in part to a mix shift to high-volume multi-
national PC manufacturers from low-volume system builders. Additionally, demand
for Windows NT Workstation moderated in anticipation of the launch of Windows
2000 Professional Version. OEM revenue of $3.61 billion in the first two
quarters of fiscal 2000 increased 14% over the first two quarters of fiscal
1999. OEM revenue grew 27% in the first quarter of fiscal 2000, reflecting
strong PC growth and increased penetration of higher-value NT Workstation.
South Pacific and Americas Region revenue in the December quarter increased 26%
to $2.21 billion. Revenue for the first half of fiscal 2000 grew 21% over the
first half of fiscal 1999 to $4.08 billion. Several products had strong revenue
growth, including Office; SQL Server; learning and entertainment software; and
online services. Organizational licensing activity was moderate. Revenue growth
was moderate in the South Pacific, the United States and Canada, and Latin
America.
Europe, Middle East, and Africa Region second quarter revenue of $1.43 billion
was up 14% compared to the second quarter of fiscal 1999. For the first two
quarters of fiscal 2000, revenue in the region totaled $2.61 billion, an
increase of 22% over the prior year Microsoft Office exhibited the highest
absolute revenue growth of the Company's products in the region. Revenue growth,
measured in constant dollars, was moderate in the United Kingdom, France, and
Germany. Weakening local currencies negatively impacted translated revenue
compared to the prior year. Second quarter revenue in the region would have
grown 22% if foreign exchange rates were constant with those of a year ago.
First quarter revenue in the region would have grown 35% if foreign exchange
rates were constant with those of a year ago.
Asia Region revenue in the December quarter of $606 million increased 56% from
the second quarter of the prior year. On a year to date basis, revenue in the
Asia region was $1.20 billion, up 68% from the comparable period. The growth in
the region reflected improved local economic conditions and strong revenue from
localized versions of Microsoft Office 2000, particularly in Japan. Revenue grew
strongly in most countries in the Asia Region.
Translated international revenue is affected by foreign exchange rates. The
impact of foreign exchange rates on revenue was negative in the December quarter
compared to a year ago, as European currencies were very weak versus the U.S.
dollar, offset partially by stronger Japanese yen versus the U.S. dollar. Had
the rates from the prior year been in effect in the second quarter of fiscal
2000, translated international revenue billed in local currencies would have
been $35 million higher. In the September quarter, the strong Japanese yen more
than offset weak European currencies and added $64 million to translated
revenue. 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
Microsoft encourages broad-based employee ownership of Microsoft stock through
an employee stock option (ESO) program in which most employees are eligible to
participate. Microsoft follows Accounting Principals Board Opinion 25 (APB 25)
to account for ESOs, which generally does not require income statement
recognition of options granted at the market price on the date of issuance, and
discloses the Black-Scholes value of option grants. A new interpretation of APB
25 requires recognition of the FICA and Medicare expense paid on option
exercises. Other
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events can also trigger recording expense, such as using the lowest price in the
30 days following an employee's start date to establish the strike price,
accelerating the vesting of options, and converting ESOs from one company to
another, as occurred with the initial public offering of Expedia, a
majority-owned subsidiary of Microsoft. These costs were reflected in each
operating expense line item in the income statement and totaled $170 million in
the second quarter and $100 million in the first quarter of fiscal 2000.
Cost of revenue as a percent of revenue was 12.4% in the second quarter, down
from 15.2% in the second quarter of the prior year. For the first half of fiscal
2000, the percentage was 12.8%, down from 15.3% for the first half of fiscal
1999. The percentage decrease resulted primarily from the trend in mix shift to
organizational licenses and lower costs associated with WebTV(R) Networks'
operations.
Research and development expenses increased 27% from the second quarter of the
prior year to $911 million. For the first two quarters of fiscal 2000, research
and development expenses increased 28% to $1.75 billion from the first two
quarters of fiscal 1999. These increases were driven primarily by higher
development headcount-related costs, including various charges related to
employee stock options.
Sales and marketing expenses were $1.03 billion in the December quarter, which
represented 16.8% of revenue, compared to 15.3% in the second quarter of the
prior year. On a year to date basis, sales and marketing expenses were $1.93
billion, up 30% over the comparable period of the prior year. Sales and
marketing expenses as a percent of revenue increased due primarily to both
higher relative marketing costs and certain employee stock option expenses.
General and administrative costs were $506 million in the second quarter
compared to $149 million in the December quarter of the prior year. For the
first two quarters of fiscal 2000, general and administrative costs were $649
million, compared to $248 million in the first two quarters of fiscal 1999. The
second quarter of fiscal 2000 included a charge for the settlement of the
lawsuit with Caldera, Inc. General and administrative costs also included
increased legal fees and certain stock option-related charges.
Other expenses and income include miscellaneous items, including gains on
foreign exchange and the recognition of Microsoft's share of joint venture
activities, including Transpoint and the MSNBC entities.
Investment Income, Gains on Sales, and Income Taxes
Second quarter investment income increased to $773 million from $337 million in
the second quarter of the prior year. Year to date investment income totaled
$1.17 billion in fiscal 2000, compared to $598 million in fiscal 1999. The
increase was due principally to realized gains of approximately $400 million in
the second quarter and $50 million in the first quarter. The larger investment
portfolio generated by cash from operations also contributed to the increase in
investment income. Realized gains in the second quarter of fiscal 1999 were
approximately $70 million.
During the first quarter of fiscal 2000, Microsoft sold the entertainment city
guide portion of MSN(TM) Sidewalk(R) to Ticketmaster Online-CitySearch, Inc.
(TMCS) for a combination of TMCS stock and warrants. Microsoft recognized a gain
of $156 million.
During the first quarter of fiscal 1999, Microsoft sold its Softimage, Inc.
subsidiary to Avid Technology, Inc for a pretax gain of $160 million.
The effective tax rate for fiscal 2000 is 34%. Excluding the tax impact of the
gain on the sale of Softimage, the effective tax rate for fiscal 1999 was 35%.
Financial Condition
The Company's cash and short-term investment portfolio totaled $17.84 billion at
December 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 equities, primarily strategic technology companies.
The Company has made large-scale investments in access providers, including
cable, telephony, and wireless communications companies. During the first
quarter of fiscal 2000, the Company purchased $400 million of Rogers
Communications convertible preferred securities and warrants. In connection
with AT&T's proposed merger with MediaOne Group, Inc., the Company agreed to
acquire MediaOne's interest in Telewest Communications plc, a leading provider
of cable television and
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residential and business cable telephony services in the United Kingdom, subject
to certain regulatory approvals and other conditions.
Microsoft and National Broadcasting Company (NBC) operate two MSNBC joint
ventures: a 24-hour cable news and information channel, and an online news
service. Microsoft is paying $220 million over a five-year period that ends in
2001 for its interest in the cable venture and one-half of the operational
funding of both joint ventures. Microsoft guarantees a portion of MSNBC debt.
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 December 31, 1999 was $34.59 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. Cash will also be used to fund ventures and strategic
opportunities. Additions to property and equipment will continue, including new
facilities and computer systems for R&D, sales and marketing, support, and
administrative staff. Commitments for constructing new buildings were $300
million on December 31, 1999.
Since fiscal 1990, Microsoft repurchased 764 million common shares while 1.90
billion shares were issued under the Company's employee stock option and
purchase plans. Microsoft enhanced its repurchase program by selling put
warrants. In January 2000, the Company announced the termination of its stock
buyback program. The market value of all outstanding stock options was $81
billion as of December 31, 1999. During December 1996, Microsoft issued 12.5
million shares of 2.75% convertible exchangeable preferred stock. Net proceeds
of $980 million were used to repurchase common shares. The Company's convertible
preferred stock matured on December 15, 1999. Each preferred share was converted
into 1.1273 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. The Company's cash and short-term investments are available
for strategic investments, mergers and acquisitions, and other potential large-
scale cash needs that may arise.
Microsoft has not paid cash dividends on its common stock.
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Part II. Other Information
Item 1. Legal Proceedings
See notes to financial statements.
Item 4. Submission of Matters to a Vote of Security Holders
At the Annual Meeting of Shareholders held on November 10, 1999, the following
proposals were adopted by the margins indicated:
1. To elect a Board of Directors to hold office until their successors are
elected and qualified.
Number of Shares
For Withheld
William H. Gates 4,488,312,569 21,695,760
Paul G. Allen 4,488,088,199 21,920,130
Richard A. Hackborn 4,488,518,818 21,489,511
David F. Marquardt 4,383,706,485 126,301,844
William G. Reed, Jr. 4,488,313,322 21,695,007
Jon A. Shirley 4,481,013,698 28,994,631
2. To approve the adoption of the 1999 Stock Option Plan for Non-Employee
Directors, including the reservation of 2,000,000 shares of common stock
thereunder.
For 3,235,830,137
Against 1,251,971,667
Abstain 22,203,713
Broker Non-vote 2,812
Item 6. Exhibits and Reports on Form 8-K
(A) Exhibits
27. Financial Data Schedule
(B) Reports on Form 8-K
The Company filed no reports on Form 8-K during the quarter ended December 31,
1999.
Items 2, 3, and 5 are not applicable and have been omitted.
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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 11, 2000 By: /s/ John G. Connors
-----------------------------------------
John G. Connors
Senior Vice President, Finance and
Administration; Chief Financial Officer
(Principal Financial and Accounting
Officer and Duly Authorized Officer)
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