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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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, 2001
[ ] 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 April
30, 2001 was 5,382,101,906.
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MICROSOFT CORPORATION
FORM 10-Q
For the Quarter Ended March 31, 2001
INDEX
Part I. Financial Information
Item 1. Financial Statements Page
----
a) Income Statements
for the Three and Nine Months Ended March 31, 2000 and 2001.. 1
b) Balance Sheets
as of June 30, 2000 and March 31, 2001....................... 2
c) Cash Flows Statements
for the Nine Months Ended March 31, 2000 and 2001............ 3
d) Stockholders' Equity Statements
for the Three and Nine Months Ended March 31, 2000 and 2001.. 4
e) Notes to Financial Statements................................ 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.......................... 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk... 17
Part II. Other Information
Item 1. Legal Proceedings............................................ 18
Item 6. Exhibits and Reports on Form 8-K............................. 18
Signature.................................................................. 19
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 Nine Months Ended
Mar. 31 Mar. 31
2000 2001 2000 2001
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Revenue $5,656 $6,456 $17,152 $18,841
Operating expenses:
Cost of revenue 752 952 2,220 2,710
Research and development 974 1,069 2,685 3,015
Sales and marketing 1,010 1,198 2,945 3,526
General and administrative 185 239 847 621
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Total operating expenses 2,921 3,458 8,697 9,872
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Operating income 2,735 2,998 8,455 8,969
Losses on equity investees and other (4) (46) (33) (126)
Investment income 882 706 2,202 2,584
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Income before income taxes 3,613 3,658 10,624 11,427
Provision for income taxes 1,228 1,207 3,612 3,771
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Income before accounting change 2,385 2,451 7,012 7,656
Cumulative effect of accounting change (net of
income taxes of $185) - - - (375)
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Net income $2,385 $2,451 $ 7,012 $ 7,281
==============================================================================================
Basic earnings per share:
Before accounting change $ 0.46 $ 0.46 $ 1.35 $ 1.44
Cumulative effect of accounting change - - - (0.07)
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$ 0.46 $ 0.46 $ 1.35 $ 1.37
==============================================================================================
Diluted earnings per share:
Before accounting change $ 0.43 $ 0.44 $ 1.27 $ 1.37
Cumulative effect of accounting change - - - (0.06)
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$ 0.43 $ 0.44 $ 1.27 $ 1.31
==============================================================================================
Average shares outstanding:
Basic 5,209 5,336 5,167 5,328
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Diluted 5,543 5,563 5,536 5,575
==============================================================================================
See accompanying notes.
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1
MICROSOFT CORPORATION
Balance Sheets
(In millions)
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June 30 Mar. 31
2000 2001 (1)
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Assets
Current assets:
Cash and equivalents $ 4,846 $ 4,149
Short-term investments 18,952 25,869
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Total cash and short-term investments 23,798 30,018
Accounts receivable 3,250 3,532
Deferred income taxes 1,708 1,841
Other 1,552 2,398
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Total current assets 30,308 37,789
Property and equipment 1,903 2,159
Equity and other investments 17,726 17,463
Other assets 2,213 2,194
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Total assets $52,150 $59,605
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Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 1,083 $ 1,246
Accrued compensation 557 501
Income taxes 585 753
Unearned revenue 4,816 5,305
Other 2,714 1,935
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Total current liabilities 9,755 9,740
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Deferred income taxes 1,027 1,775
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Commitments and contingencies
Stockholders' equity:
Common stock and paid-in capital -
shares authorized 12,000; outstanding 5,283 and 5,336 23,195 27,647
Retained earnings, including accumulated other comprehensive
income of $1,527 and $604 18,173 20,443
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Total stockholders' equity 41,368 48,090
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Total liabilities and stockholders' equity $52,150 $59,605
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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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Nine Months Ended
Mar. 31
2000 2001
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Operations
Net income $ 7,012 $ 7,281
Cumulative effect of accounting change, net of tax - 375
Depreciation, amortization, and other noncash items 945 972
Net recognized gains on investments (1,078) (943)
Stock option income tax benefits 4,002 1,271
Deferred income taxes 449 1,357
Unearned revenue 4,278 5,141
Recognition of unearned revenue from prior periods (4,058) (4,652)
Accounts receivable (558) (281)
Other current assets (328) (557)
Other long-term assets (654) (228)
Other current liabilities (1,272) 107
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Net cash from operations 8,738 9,843
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Financing
Common stock issued 1,750 1,095
Common stock repurchased (4,872) (4,381)
Structured stock repurchase - (264)
Sales/(repurchases) of put warrants 472 (405)
Preferred stock dividends (13) -
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Net cash used for financing (2,663) (3,955)
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Investing
Additions to property and equipment (617) (781)
Purchases of investments (28,607) (49,966)
Maturities of investments 3,086 4,443
Sales of investments 20,216 39,719
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Net cash used for investing (5,922) (6,585)
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Net change in cash and equivalents 153 (697)
Effect of exchange rates on cash and equivalents 64 -
Cash and equivalents, beginning of period 4,975 4,846
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Cash and equivalents, end of period $ 5,192 $ 4,149
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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 Nine Months Ended
Mar. 31 Mar. 31
2000 2001 2000 2001
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Convertible preferred stock
Balance, beginning of period $ - $ - $ 980 $ -
Conversion of preferred to common stock - - (980) -
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Balance, end of period - - - -
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Common stock and paid-in capital
Balance, beginning of period 18,878 27,178 13,844 23,195
Common stock issued 751 432 2,843 4,143
Common stock repurchased (20) (73) (186) (293)
Structured stock repurchase - (264) - (264)
Sales/(repurchases) of put warrants - - 472 (405)
Stock option income tax benefits 1,366 374 4,002 1,271
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Balance, end of period 20,975 27,647 20,975 27,647
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Retained earnings
Balance, beginning of period 15,711 19,244 13,614 18,173
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Net income 2,385 2,451 7,012 7,281
Other comprehensive income:
Cumulative effect of accounting change - - - (75)
Net gain on derivative instruments - 136 - 635
Net unrealized investments gains/(losses) 583 (285) 2,724 (1,451)
Translation adjustments and other 138 (20) 166 (32)
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Comprehensive income 3,106 2,282 9,902 6,358
Preferred stock dividends - - (13) -
Common stock repurchased - (1,083) (4,686) (4,088)
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Balance, end of period 18,817 20,443 18,817 20,443
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Total stockholders' equity $39,792 $48,090 $39,792 $48,090
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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, as well as the
accounting change to adopt Statement of Financial Accounting Standards (SFAS)
133, Accounting for Derivative Instruments and Hedging Activities, necessary for
their fair presentation in conformity with U.S. 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, concessions 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
2000 Form 10-K. Certain reclassifications have been made for consistent
presentation.
Accounting Change
Effective July 1, 2000, Microsoft adopted SFAS 133, which establishes accounting
and reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. All
derivatives, whether designated in hedging relationships or not, are required to
be recorded on the balance sheet at fair value. If the derivative is designated
as a fair value hedge, the changes in the fair value of the derivative and of
the hedged item attributable to the hedged risk are recognized in earnings. If
the derivative is designated as a cash flow hedge, the effective portions of
changes in the fair value of the derivative are recorded in other comprehensive
income (OCI) and are recognized in the income statement when the hedged item
affects earnings. Ineffective portions of changes in the fair value of cash flow
hedges are recognized in earnings.
The adoption of SFAS 133 on July 1, 2000, resulted in a cumulative pre-tax
reduction to income of $560 million ($375 million after-tax) and a cumulative
pre-tax reduction to OCI of $112 million ($75 million after-tax). The reduction
to income was mostly attributable to a loss of approximately $300 million
reclassified from OCI for the time value of options and a loss of approximately
$250 million reclassified from OCI for derivatives not designated as hedging
instruments. The reduction to OCI was mostly attributable to losses of
approximately $670 million on cash flow hedges offset by reclassifications out
of OCI of the approximately $300 million loss for the time value of options and
the approximately $250 million loss for derivative instruments not designated as
hedging instruments. The net derivative losses included in OCI as of July 1,
2000, will be reclassified into earnings during the twelve months ended June 30,
2001.
The Company uses derivative instruments to manage exposures to foreign currency,
securities price, and interest rate risks. The Company's objectives for holding
derivatives are to minimize the risks using the most effective methods to
eliminate or reduce the impacts of these exposures.
Foreign Currency Risk
Certain forecasted transactions and assets are exposed to foreign currency risk.
The Company monitors its foreign currency exposures daily to maximize the
overall effectiveness of its foreign currency hedge positions. Principal
currencies hedged include the Euro, Japanese yen, British pound, and Canadian
dollar. Options used to hedge a portion of forecasted international revenue for
up to two years in the future are designated as cash flow hedging instruments.
Options and forwards not designated as hedging instruments under SFAS 133 are
also used to hedge the impact of the variability in exchange rates on accounts
receivable and collections denominated in certain foreign currencies.
Securities Price Risk
Strategic equity investments are subject to market price risk. From time to
time, the Company uses and designates options to hedge fair values and cash
flows on certain equity securities. The security, or forecasted sale thereof,
selected for hedging is determined by market conditions, up-front costs, and
other relevant factors. Once established, the hedges are not dynamically managed
or traded, and are generally not removed until maturity.
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5
Interest Rate Risk
Fixed-income securities are subject to interest rate risk. The fixed-income
portfolio is diversified and consists primarily of investment grade securities
to minimize credit risk. The Company routinely uses options, not designated as
hedging instruments, to hedge its exposure to interest rate risk in the event of
a catastrophic increase in interest rates.
Other Derivatives
In addition, the Company may invest in warrants to purchase securities of other
companies as a strategic investment. Warrants that can be net share settled are
deemed derivative financial instruments and are not designated as hedging
instruments.
For options designated either as fair value or cash flow hedges, changes in the
time value are excluded from the assessment of hedge effectiveness. Hedge
ineffectiveness, determined in accordance with SFAS 133, had no impact on
earnings for the three or nine months ended March 31, 2001. No fair value hedges
or cash flow hedges were derecognized or discontinued for the three or nine
months ended March 31, 2001.
For the three months ended March 31, 2001, investment income included a net
unrealized non-cash loss of $90 million, comprised of a $27 million gain for
changes in the time value of options for fair value hedges, $42 million loss for
changes in the time value of options for cash flow hedges, and $75 million loss
for changes in the fair value of derivative instruments not designated as
hedging instruments. For the nine months ended March 31, 2001, investment income
included a net unrealized non-cash loss of $516 million, comprised of a $203
million gain for changes in the time value of options for fair value hedges,
$121 million loss for changes in the time value of options for cash flow hedges,
and $598 million loss for changes in the fair value of derivative instruments
not designated as hedging instruments.
Derivative gains and losses included in OCI are reclassified into earnings at
the time forecasted revenue or the sale of an equity investment is recognized.
During the three months ended March 31, 2001, $46 million of derivative gains
were reclassified to revenue. During the nine months ended March 31, 2001, $154
million of derivative gains were reclassified to revenue and $416 million of
derivative losses were reclassified to investment income. The derivative losses
reclassified to investment income were offset by gains on the item being hedged.
The Company estimates that $179 million of net derivative gains included in
other comprehensive income will be reclassified into earnings within the next
twelve months.
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,
outstanding put warrants using the "reverse treasury stock" method, and
outstanding stock options using the "treasury stock" method.
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6
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 Nine Months Ended
Mar. 31 Mar. 31
2000 2001 2000 2001
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Income before accounting change (A) $2,385 $2,451 $7,012 $7,656
Preferred stock dividends - - (13) -
- -----------------------------------------------------------------------------------------------------
Net income available for common shareholders (B) $2,385 $2,451 $6,999 $7,656
=====================================================================================================
Average outstanding shares of common stock (C) 5,209 5,336 5,167 5,328
Dilutive effect of:
Put warrants - 35 - 30
Preferred stock - - 9 -
Employee stock options 334 192 360 217
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Common stock and common stock equivalents (D) 5,543 5,563 5,536 5,575
- -----------------------------------------------------------------------------------------------------
Earnings per share before accounting change:
Basic (B/C) $ 0.46 $ 0.46 $ 1.35 $ 1.44
=====================================================================================================
Diluted (A/D) $ 0.43 $ 0.44 $ 1.27 $ 1.37
=====================================================================================================
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 items such as 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 March 31, 2001, unearned revenue was $5.31 billion,
compared to $4.46 billion at March 31, 2000. Desktop Applications unearned
revenue was $2.05 billion, compared to $1.65 billion at March 31, 2000. Desktop
Platforms unearned revenue was $2.55 billion, compared to $2.27 billion at March
31, 2000. Enterprise Software and Services unearned revenue was $387 million,
compared to $383 million at March 31, 2000. Unearned revenue associated with
Consumer Software, Services, and Devices and Other was $324 million, compared to
$166 million a year ago.
Stockholders' Equity
During the March quarter, the Company repurchased 17.2 million shares of common
stock for $1.2 billion. The Company also entered into a structured stock
repurchase transaction giving it the right to acquire 5.1 million of its shares
(2.55 million shares in October 2001 and 2.55 million shares in June 2002) in
exchange for an up-front net payment of $264 million. There were no shares
repurchased in the comparable quarter of the prior year. For the first nine
months of fiscal 2001, the Company repurchased 65.4 million shares of common
stock for $4.4 billion, compared to 54.7 million shares of common stock for $4.9
billion in the prior year.
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.
During the March quarter of fiscal 2001, the Company issued 2.8 million shares
to settle a portion of the outstanding put warrants. On March 31, 2001, warrants
to put 94 million shares were outstanding with strike prices ranging from $70 to
$78 per share. The put warrants expire between June 2001 and March 2003. 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.
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7
During 1996, Microsoft issued 12.5 million shares of 2.75% convertible
exchangeable principal-protected preferred stock. The Company's convertible
preferred stock matured on December 15, 1999. Each preferred share was converted
into 1.1273 common shares.
Investment Income
The components of investment income are as follows:
Three Months Ended Nine Months Ended
Mar. 31 Mar. 31
(In millions) 2000 2001 2000 2001
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Dividends $ 97 $100 $ 272 $ 285
Interest 331 496 852 1,356
Net recognized gains on investments 454 110 1,078 943
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Investment income $882 $706 $2,202 $2,584
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Contingencies
On May 18, 1998, the Antitrust Division of the U.S. Department of Justice (DOJ)
and a group of 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 and ended with closing arguments on September 21, 1999. On
November 5, 1999, Judge Jackson issued his Findings of Fact. On April 3, 2000
the Court entered its Conclusions of Law, determining that Microsoft "tied"
Internet Explorer and Windows 95/98 in violation of Section 1 of the Sherman
Act, that Microsoft violated Section 2 of the Sherman Act by taking actions to
maintain its monopoly in the desktop-PC operating system market, and that
Microsoft attempted to monopolize the Internet browser market in violation of
Section 2 of the Sherman Act. The Court also held that Microsoft did not violate
Section 1 of the Sherman Act by entering into a number of contracts challenged
by the government. The Court established a schedule for consideration of the
remedy to be imposed in a final judgment. On April 28, 2000, the plaintiffs
submitted a joint proposed remedy that included a proposed break-up of Microsoft
into two companies, an operating systems company, and a company that would own
all of Microsoft's other products and businesses. Microsoft submitted its
proposed remedy and its proposal for further remedy proceedings on May 10, 2000.
On June 7, 2000, Judge Jackson entered the government's proposed order nearly
verbatim as his final judgment in the case. That judgment orders a divestiture
that will create two separate companies, an "Operating Systems Business" and an
"Applications Business," to be implemented one year following a final decision
on appeal. It also provides for a broad range of "conduct" remedies that would
have gone into effect in 90 days, absent a stay. On June 13, 2000, Microsoft
appealed to the United States Court of Appeals. The Court of Appeals immediately
entered an order notifying the parties that the Court would hear all matters
related to this appeal en banc. The government then asked Judge Jackson to enter
an order certifying the case for direct appeal to the Supreme Court. On June 20,
2000, Judge Jackson certified the case for direct appeal to the Supreme Court
and simultaneously granted Microsoft's request to stay the entire remedy pending
final appeal. On September 26, 2000 the Supreme Court remanded Microsoft's
appeal to the Court of Appeals. Microsoft's opening brief to the Court of
Appeals was filed on November 27, 2000. The government's brief was filed on
January 12, 2001, and Microsoft's reply was filed on January 29, 2001. The Court
heard oral arguments on the appeals on February 26 and 27, 2001.
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8
In other ongoing investigations, the DOJ and several state Attorneys General
have requested information from Microsoft concerning various issues. In
addition, the European Commission has instituted proceedings in which it alleges
that Microsoft has failed to disclose information that Sun claims it needs to
interoperate fully with Windows 2000 clients and has engaged in discriminatory
licensing of such technology. The remedies sought, though not fully defined,
include mandatory disclosure of Microsoft intellectual property concerning
Windows operating systems and imposition of fines. Microsoft denies the European
Commission's allegations and intends to contest the proceedings vigorously.
A large number of overcharge class action lawsuits have been initiated against
Microsoft. These cases allege that Microsoft has competed unfairly and
unlawfully monopolized alleged markets for operating systems and certain
software applications and seek to recover alleged overcharges that the
complaints contend Microsoft charged for these products. Microsoft believes the
claims are without merit and is vigorously defending the cases. To date,
Microsoft has won dismissals of all claims for damages by indirect purchasers
under federal law and in 14 separate state court proceedings. Claims on behalf
of foreign purchasers have also been dismissed. Plaintiffs have appealed most of
these rulings. While no trials or other proceedings have been held concerning
any liability issues, courts in several states have ruled that these cases may
proceed as class actions.
Two purported class action employment discrimination cases are pending against
Microsoft, Donaldson v. Microsoft, a class case consolidating three separately
filed class action complaints filed in October 2000 and February 2001 in Federal
court in Seattle, Washington, and Jackson v. Microsoft, an amendment to an
existing case alleging class claims filed on January 3, 2001 in Federal court in
Washington, D.C. Microsoft's motion to transfer the Jackson case to Federal
court in Seattle was granted on May 3, 2001. The Donaldson plaintiffs purport to
represent a nationwide class of current and former African American and female
salaried Microsoft employees and seek injunctive relief, an unspecified amount
of compensatory and punitive damages, and attorneys' fees. The Jackson
plaintiffs purport to represent a nationwide class of current and former African
American Microsoft employees and seeks injunctive relief, $5 billion in
compensatory and punitive damages, and attorneys' fees. Both cases allege that
Microsoft's compensation, evaluation and promotion policies are discriminatory
with respect to the plaintiffs in violation of Title VII of the 1964 Civil
Rights Act and 42 U.S.C. (S) 1981. Microsoft denies the allegations and is
vigorously defending both 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.
- --------------------------------------------------------------------------------
9
Segment Information
(In millions)
- ------------------------------------------------------------------------------------------------------------------------------
Desktop and Consumer
Enterprise Software, Consumer
Three Months Software Services, Commerce Reconciling
Ended Mar. 31 and Services and Devices Investments Other Amounts Consolidated
- ------------------------------------------------------------------------------------------------------------------------------
2000
Revenue $ 5,048 $ 426 $ 46 $190 $ (54) $ 5,656
Operating income (loss) 3,015 (287) (10) 47 (30) 2,735
- ------------------------------------------------------------------------------------------------------------------------------
2001
Revenue $ 5,633 $ 497 $129 $172 $ 25 $ 6,456
Operating income (loss) 3,467 (490) (48) 34 35 2,998
- ------------------------------------------------------------------------------------------------------------------------------
Desktop and Consumer
Enterprise Software, Consumer
Nine Months Software Services, Commerce Reconciling
Ended Mar. 31 and Services and Devices Investments Other Amounts Consolidated
- ------------------------------------------------------------------------------------------------------------------------------
2000
Revenue $15,204 $1,213 $ 94 $522 $ 119 $17,152
Operating income (loss) 9,851 (728) (28) 78 (718) 8,455
- ------------------------------------------------------------------------------------------------------------------------------
2001
Revenue $16,719 $1,439 $325 $516 $(158) $18,841
Operating income (loss) 10,834 (1,187) (112) 85 (651) 8,969
- ------------------------------------------------------------------------------------------------------------------------------
Desktop and Enterprise Software and Services Revenue:
Three Months Ended Nine Months Ended
Mar. 31 Mar. 31
(In millions) 2000 2001 2000 2001
- ------------------------------------------------------------------------------------------------------------------------------
Desktop Applications $2,151 $2,368 $ 6,734 $ 6,969
Desktop Platforms 1,888 2,025 5,549 6,198
- ------------------------------------------------------------------------------------------------------------------------------
Desktop Software 4,039 4,393 12,283 13,167
Enterprise Software and Services 1,009 1,240 2,921 3,552
- ------------------------------------------------------------------------------------------------------------------------------
Total Desktop and Enterprise Software
and Services $5,048 $5,633 $15,204 $16,719
- ------------------------------------------------------------------------------------------------------------------------------
In September 2000, Microsoft changed the composition of its segments to reflect
the re-organization around Microsoft .NET, the Company's vision for the next-
generation of Internet-based products and services. Prior year disclosures have
been restated for consistent presentation. Microsoft has four segments: Desktop
and Enterprise Software and Services; Consumer Software, Services, and Devices;
Consumer Commerce Investments; and Other. Desktop and Enterprise Software and
Services operating segment includes Desktop Applications, Desktop Platforms, and
Enterprise Software and Services. Desktop Applications include Microsoft Office,
Project, Visio, and client access licenses for Windows 2000 Server, Windows NT
Server, Exchange, and BackOffice. Desktop Platforms include Windows 2000
Professional, Windows NT Workstation, Windows Millennium Edition (Windows Me),
Windows 98, and other desktop operating systems. Enterprise Software and
Services includes Windows NT Server and Windows 2000 Server operating systems,
SQL Server and client access licenses, Exchange Server, developer tools,
consulting services, product support services, and training and certification.
Consumer Software, Services, and Devices operating segment includes MSN Internet
access, MSN network services, WebTV Internet access and services, gaming,
learning and productivity software, mobile and wireless devices, and embedded
systems. Consumer Commerce Investments operating segment includes Expedia, Inc.,
the HomeAdvisor online real estate service, and the CarPoint online automotive
service. Other includes Hardware and Press.
- --------------------------------------------------------------------------------
10
Segment information is presented in accordance with SFAS 131, Disclosures about
Segments of an Enterprise and Related Information. This standard is based on a
management approach, which requires segmentation based upon the Company's
internal organization and disclosure of revenue and operating income based upon
internal accounting methods. The Company's financial reporting systems present
various data for management to run the business, including profit and loss
statements (P&Ls) prepared on a basis not consistent with U.S. generally
accepted accounting principles (GAAP). Assets are not allocated to segments for
internal reporting purposes.
Reconciling items for revenue include certain elements of unearned revenue and
the treatment of certain channel inventory amounts and estimates. In addition to
the reconciling items for revenue, reconciling items for operating income (loss)
for the three months ended March 31, include general and administrative expenses
($185 million in 2000 and $239 million in 2001), certain research expenses ($33
million in 2000 and $37 million in 2001), and other corporate level adjustments.
For the nine months ended March 31, reconciling items for operating income
(loss) include general and administrative expenses ($847 million in 2000 and
$621 million in 2001), certain research expenses ($104 million in 2000 and $111
million in 2001), and other corporate level adjustments. The internal P&Ls use
accelerated methods of depreciation and amortization. Additionally, losses on
equity investees and minority interest are classified in operating income for
internal reporting presentations.
Subsequent Event
On April 5, 2001, the Company announced the completion of its acquisition of
Great Plains Software, Inc., a leading supplier of mid-market business
applications. The acquisition is structured as a stock purchase and is valued at
approximately $1.1 billion. Each share of Great Plains common stock will be
exchanged for 1.1 shares of Microsoft common stock.
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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 servers, personal computers (PCs), and
intelligent devices; 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 hardware devices; provides consulting services; trains and
certifies system integrators and developers; and researches and develops
advanced technologies for future software products.
Management's Discussion and Analysis contains statements that are forward-
looking. These statements are based on current expectations that are based on
assumptions that are subject to risks and uncertainties. Actual results could
differ materially because of factors such as: general economic conditions;
changes in the rate of PC shipments; technological shifts; customer demand;
market acceptance of new products and services; competitive products, services
and pricing; changes in product and service mix; delay in product ship
schedules; product life cycles; currency fluctuations; sale terms and
conditions; financial market volatility affecting the value of Microsoft's
investments that may result in a reduction in carrying value and recognition of
losses; litigation; and other factors discussed in the Company's 2000 Form 10-K
and other reports and filings with the Securities and Exchange Commission.
Revenue
Revenue for the third quarter of fiscal year 2001 was $6.46 billion, an increase
of 14% over the third quarter of fiscal 2000. For the first nine months of
fiscal year 2001, revenue was $18.84 billion, an increase of 10% over the first
nine months of fiscal 2000. The revenue growth was driven primarily by licensing
of Microsoft Windows 2000 Professional, Microsoft SQL Server, and the other .NET
Enterprise Servers. Revenue from Consumer Software, Services, and Devices also
grew strongly.
Product Revenue
Microsoft has four segments: Desktop and Enterprise Software and Services;
Consumer Software, Services, and Devices; Consumer Commerce Investments; and
Other. The Management Discussion and Analysis presentation of revenue differs
from that reported under the Company's Segment Information since reconciling
amounts are allocated to the segments.
Desktop and Enterprise Software and Services includes Desktop Applications;
Desktop Platforms; and Enterprise Software and Services. In the third quarter of
fiscal 2001, Desktop and Enterprise Software and Services revenue was $5.72
billion, up 13% from $5.06 billion. For the first nine months of fiscal year
2001, Desktop and Enterprise Software and Services revenue was $16.57 billion,
up 8% from $15.27 billion in the prior year.
Desktop Applications includes revenue from Microsoft Office; Microsoft Project;
Visio; client access licenses (CALs) for Windows NT Server and Windows 2000
Server, Exchange, and BackOffice; and bCentral. Revenue from Desktop
Applications was $2.41 billion in the March quarter of fiscal 2001, up 7% from
$2.26 billion in the prior year. Revenue from client access licenses showed a
strong increase from the third quarter of the prior year related to strong
licensing growth of Windows NT Server and Windows 2000 Server CALs, Exchange
CALs, and BackOffice CALs. Revenue from Desktop Applications was $7.04 billion
in the first nine months of fiscal 2001, which was flat compared to revenue of
$7.01 billion in the prior year. Reported revenue in the first nine months of
fiscal 2000 was positively impacted by $214 million related to the fulfillment
of the Microsoft Office 2000 Technology Guarantee.
Desktop Platforms includes revenue from Windows 2000 Professional, Windows NT
Workstation, Windows Millennium Edition (Windows Me), Windows 98, and other
desktop operating systems. Desktop Platforms revenue was $2.05 billion in the
third quarter, representing 16% growth from the third quarter of the prior year.
Revenue was $6.00 billion in the first nine months of fiscal 2001, representing
14% growth from the first nine months of fiscal 2000. Continued strong adoption
of Windows 2000 Professional contributed significantly to the strong revenue
growth. However, the slowdown in overall PC shipments compared to growth rates
in the prior year hampered revenue growth from Windows Me and Windows 98
operating systems.
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Enterprise Software and Services includes Enterprise Platforms; Server
Applications; Developer Tools and Services; and Enterprise Services. As a result
of the continued adoption of Microsoft's .NET Enterprise Server offerings,
Server Applications, including Exchange Server and SQL Server and client access
licenses, increased 53% compared to the March quarter of fiscal 2000. SQL Server
and client access licenses revenue growth was robust compared to the prior
year's third quarter. Other server application products revenue experienced
strong growth due to migration to the new product versions, Exchange 2000 Server
and BackOffice Server 2000. Enterprise Platforms, which includes Windows 2000
Server and Windows NT Server operating systems, continues to make progress with
new mission critical deployments and grew 5% from the third quarter of fiscal
2000. Enterprise Services revenue, representing consulting and product support
services, was up 38% compared to the prior year's comparable quarter. Revenue
from Developer Tools and Services declined slightly. Enterprise Software and
Services revenue in the first nine months of fiscal 2001 increased 18% to $3.54
billion. Enterprise Services revenue increased 33%, Server Applications revenue
increased 31%, Enterprise Platforms revenue increased 8%, and revenue from
Developer Tools and Services increased 2% from the prior year comparable period.
Consumer Software, Services, and Devices includes MSN Internet access; MSN
network services; WebTV Internet access and services; PC and online games;
learning and productivity software; mobile and wireless devices; and embedded
systems. Consumer Software, Services, and Devices revenue reached $460 million
in the third quarter of fiscal 2001, up 22% from the third quarter of the prior
year. Revenue growth from MSN network services revenue slowed due to the decline
in the online advertising marketplace, however, MSN Internet access revenue grew
strongly as a result of an increased subscriber base, partially offset by a
decline in the average revenue per subscriber due to a larger mix of subscribers
contracted under rebate programs. Learning and productivity software revenue and
PC and online games revenue declined from the March quarter of fiscal 2000, due
to softness in the overall consumer market. Consumer Software, Services, and
Devices revenue reached $1.45 billion in the first nine months of fiscal 2001,
up 20% from the first nine months of the prior year. MSN Internet access, MSN
network services revenue and revenue from embedded systems grew strongly from
the prior year period.
Consumer Commerce Investments include Expedia, Inc., the HomeAdvisor online real
estate service, and the CarPoint online automotive service. Third quarter
revenue totaled $129 million, compared to $46 million in the prior year's third
quarter. Revenue for the first nine months totaled $325 million, compared to $94
million in the prior year. Acquisitions of Travelscape.com and VacationSpot.com
by Expedia, Inc., and increased product offerings from Expedia led to the strong
revenue growth compared to the prior year.
Other primarily includes Hardware and Microsoft Press. Other revenue was $149
million in the March quarter of fiscal 2001, declining from $176 million
reported in the prior year's March quarter. For the nine months of fiscal 2001,
Other revenue was $502 million, compared to $577 million reported in the prior
year. Lower sales of gaming devices and other hardware peripherals resulted in
declining revenue compared to the prior year.
Distribution Channels
Microsoft distributes its products primarily through OEM licenses,
organizational licenses, online services and products, 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 retail packaged products via these
channels are primarily to and through distributors and resellers.
OEM third quarter revenue was $1.99 billion, up 19% from revenue of $1.67
billion in the comparable quarter of fiscal 2000. Although overall license
growth was impacted by a slowdown in PC shipments, adoption of Windows 2000
Professional and Windows NT Workstation in the OEM channel increased
substantially resulting in higher average revenue per license. Additionally,
revenue growth was positively impacted by the recognition of unearned revenue
from prior periods when OEM growth rates were higher. For the first nine months,
OEM revenue was $5.86 billion, up 11% from revenue of $5.28 billion in the
comparable period of fiscal 2000. The revenue growth was affected by a slowdown
in PC shipments. However, migration to Windows NT Workstation and Windows 2000
Professional in the OEM channel increased.
South Pacific and Americas Region revenue in the March quarter was $2.42
billion, up 20% compared to $2.02 billion in the prior year. Revenue growth in
the region, principally the United States, benefited from continued migration to
the .NET Enterprise family of products, increased focus on customer alignment
and sales force automation, and successful anti-piracy efforts. In terms of
products, the regional growth was led by strong licensing of Windows 2000
Professional and the family of .NET Enterprise Servers, especially SQL Server
2000. Revenue
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13
from enterprise consulting and support services, MSN online, and consumer
commerce investments also grew strongly. Office integrated suites revenue also
showed a healthy increase from the prior year's comparable quarter. Revenue in
the first nine months of fiscal 2001 was $6.98 billion, up 15% compared to $6.09
billion in the prior year. Revenue growth was attributed to strong licensing of
Windows 2000 Professional, and the family of .NET Enterprise Servers, especially
SQL Server 2000. Revenue from enterprise consulting and support services, MSN
online, and consumer commerce investments also grew strongly. The revenue growth
resulted primarily from increased U.S. revenue.
Europe, Middle East, and Africa Region revenue was $1.20 billion, declining
slightly from $1.26 billion reported in the third quarter of the prior year. For
the first nine months of fiscal 2001, revenue was $3.72 billion, down 4% from
the first nine months of fiscal 2000. Weakening local currencies negatively
impacted translated revenue compared to the prior year. Revenue in the region
would have increased 3% in the third quarter and 6% in the first nine months of
fiscal 2001 if foreign exchange rates were constant with those of the prior
year. Revenue from Windows 2000 Professional and the .NET Enterprise Server
family of products was very healthy.
Asia Region revenue increased 18% to $836 million from the March quarter of the
prior year. For the first nine months of fiscal 2001, revenue increased 20% to
$2.28 billion from the similar period of the prior year. The region's growth
rate reflected strong revenue from localized versions of Microsoft Office 2000,
especially the Office Personal suite and .NET Server applications. Revenue in
the region would have increased 27% compared to the third quarter of fiscal 2000
if foreign exchange rates were constant with those of the prior year. Revenue
for the first nine months of fiscal 2001 would have grown 21% if foreign
exchange rates were constant with those of the prior year. During the March
quarter, revenue growth was particularly strong in Korea and Hong Kong, a result
of successful anti-piracy efforts, and in the South Asia region. For the first
nine months of fiscal 2001, revenue grew strongly in nearly all countries in the
Asia region.
Translated international revenue is affected by foreign exchange rates. As noted
above, the net impact of foreign exchange rates on revenue was negative in the
March quarter compared to a year ago, due to weaker European and Japanese
currencies versus the U.S. dollar. Had the rates from the prior year's
comparable quarter been in effect in the third quarter of fiscal 2001,
translated international revenue billed in local currencies would have been
approximately $160 million higher. The net impact of foreign exchange rates on
revenue was also negative in the first nine months of fiscal 2001 compared to a
year ago, due primarily to weaker European currencies versus the U.S. dollar.
Had the rates from the prior year's comparable period been in effect in the
first nine months of fiscal 2001, translated international revenue billed in
local currencies would have been approximately $425 million higher. 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
Cost of revenue was $952 million or 14.7% as a percent of revenue in the third
quarter, up from $752 million or 13.3% as a percent of revenue in the third
quarter of the prior year. For the first nine months of fiscal 2001, cost of
revenue was $2.71 billion or 14.4% as a percentage of revenue, up from $2.22
billion or 12.9% as a percentage of revenue in the first nine months of fiscal
2000. Higher support and service costs associated with the MSN Internet access
and MSN network services were partially offset by the lower relative costs
associated with organizational licensing and the drop in the mix of packaged
product versus the prior year, which carries a higher relative cost than
organizational licensing.
Research and development expenses in the third quarter increased 10% from the
third quarter of the prior year to $1.07 billion. The increase in R&D expenses
was the result of higher headcount-related costs, partially offset by lower
development and localization costs. Research and development expenses in the
first nine months of fiscal 2001 increased 12% from the comparable prior year
period. The increase in R&D expenses in the first nine months of fiscal 2001 was
the result of higher headcount-related costs and investments in new product
initiatives.
Sales and marketing expenses were $1.20 billion in the March quarter, or 18.6%
of revenue, compared to $1.01 billion in the third quarter of the prior year, or
17.9% of revenue. Sales and marketing expenses as a percent of revenue increased
due to higher relative headcount related costs and increased marketing costs
associated with the Microsoft Agility advertising campaign, co-marketing for MSN
Internet Access through distribution partners, bCentral small business portal,
and other new sales initiatives. For the first nine months of fiscal 2001, sales
and marketing expenses were $3.53 billion, or 18.7% of revenue, compared to
$2.95 billion, or 17.2% of revenue, in the first nine months of fiscal 2000. The
increase was due to higher relative headcount related costs, higher marketing
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14
costs and sales expenses associated with MSN, costs associated with the
Microsoft Agility advertising campaign, and other new sales initiatives.
General and administrative costs were $239 million in the third quarter compared
to $185 million in the comparable quarter of the prior year. General and
administrative costs increase from the third quarter of fiscal 2000, due to
higher headcount-related costs and legal fees. General and administrative costs
were $621 million in the first nine months compared to $847 million in the
comparable period of the prior year. In the December quarter of fiscal 2000,
general and administrative costs included a charge related to the settlement of
the lawsuit with Caldera, Inc.
Non-operating Items, Investment Income, and Income Taxes
Losses on equity investees and other incorporates Microsoft's share of income or
loss from the MSNBC entities, Avanade, Wireless Knowledge, StarBand
Communications, and other investments accounted for using the equity method.
Losses on equity investees and other increased $42 million over the third
quarter of fiscal 2000 and $93 million over the first nine months of fiscal
2000, primarily reflecting an increase in the number of such investments during
fiscal 2001.
Third quarter investment income was $706 million compared to $882 million in the
third quarter of the prior year. The decrease was due to lower net recognized
gains, partially offset by higher interest income from the larger investment
portfolio. Net recognized gains represented $110 million of the investment
income in the third quarter of fiscal 2001, a decrease of $344 million from the
prior year's comparable quarter, reflecting $364 million in impairments of
certain investments and $90 million of net losses attributable to derivative
instruments, partially offset by higher net gains from the sales of investments.
Interest and dividend income reached $596 million compared to $428 million in
the prior year's comparable quarter. For the first nine months of 2001,
investment income was $2.58 billion compared to $2.20 billion in the similar
period of the prior year. Interest and dividend income increased $517 million,
reflecting the larger investment portfolio. Net recognized gains on investments
decreased $135 million, reflecting $882 million in impairments of certain
investments and $516 million of net losses attributable to derivative
instruments, partially offset by higher net gains from the sales of investments,
including a gain from Microsoft's investment in Titus Communications (which was
merged with Jupiter Telecommunications) and the closing of the sale of
Transpoint to CheckFree Holdings Corp.
Investments are considered to be impaired when a decline in fair value is judged
to be other than temporary. Microsoft employs a systematic methodology that
considers available evidence in evaluating potential impairment of its
investments. In the event that the cost of an investment exceeds its fair value,
Microsoft evaluates, among other factors, the duration and extent to which the
fair value is less than cost; the financial health of and business outlook for
the investee, including industry and sector performance, changes in technology,
and operational and financing cash flow factors; and Microsoft's intent and
ability to hold the investment, including strategic factors. Once a decline in
fair value is determined to be other than temporary, an impairment charge is
recorded and a new cost basis in the investment is established.
Effective July 1, 2000, Microsoft adopted SFAS 133, which establishes accounting
and reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. All
derivatives, whether designated in hedging relationships or not, are required to
be recorded on the balance sheet at fair value. If the derivative is designated
as a fair value hedge, the changes in the fair value of the derivative and the
hedged item are recognized in earnings. If the derivative is designated as a
cash flow hedge, changes in the fair value of the derivative are recorded in
other comprehensive income and are recognized in the income statement when the
hedged item affects earnings.
The adoption of SFAS 133 on July 1, 2000, resulted in a cumulative pre-tax
reduction to income of $560 million ($375 million after-tax) and a cumulative
pre-tax reduction to OCI of $112 million ($75 million after-tax). The reduction
to income was mostly attributable to a loss of approximately $300 million
reclassified from OCI for the time value of options and a loss of approximately
$250 million reclassified from OCI for derivatives not designated as hedging
instruments. The reduction to OCI was mostly attributable to losses of
approximately $670 million on cash flow hedges offset by the reclassifications
out of OCI of the approximately $300 million loss for the time value of options
and the approximately $250 million loss for derivative instruments not
designated as hedging instruments.
The effective tax rate for fiscal 2001 is estimated to be 33%. The effective tax
rate for fiscal 2000 was 34%.
Financial Condition
Cash and short-term investments totaled $30.02 billion as of March 31, 2001.
Cash flow from operations was $9.84 billion in the first nine months of fiscal
2001, an increase of $1.11 billion from the first nine months of the prior year,
reflecting the growth in earned and unearned revenue. The stock option income
tax benefit decrease of $2.73 billion,
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15
reflecting decreased stock option exercises by employees, was offset by
favorable changes in deferred taxes and income taxes payable. Cash used for
financing was $3.96 billion in the first nine months of fiscal 2001, an increase
of $1.29 billion from the first nine months of the prior year. The increase
primarily reflects repurchases of put warrants in the current fiscal year
compared to the sale of put warrants in the prior fiscal year. During the first
nine months of fiscal 2001, the Company repurchased 65.4 million shares of
common stock under its share repurchase program, compared to 54.7 million shares
repurchased in the first nine months of the prior year. Cash used for investing
was $6.59 billion in the first nine months of fiscal 2001, an increase of $663
million from the first nine months of the prior year, reflecting the increase in
the investment portfolio.
On April 5, 2001, the Company announced the completion of its acquisition of
Great Plains Software, Inc., a leading supplier of mid-market business
applications. The acquisition is structured as a stock purchase and is valued at
approximately $1.1 billion. Each share of Great Plains common stock will be
exchanged for 1.1 shares of Microsoft common stock.
Microsoft has no material long-term debt. Stockholders' equity at March 31, 2001
was $48.09 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
R&D, sales and marketing, support, and administrative staff. Commitments for
constructing new buildings were $212 million on March 31, 2001.
Since fiscal 1990, Microsoft has repurchased 830 million common shares while
2.08 billion shares were issued under the Company's employee stock option and
purchase plans. The market value of all outstanding stock options was $51
billion as of March 31, 2001. During December 1996, Microsoft issued 12.5
million shares of 2.75% convertible exchangeable preferred stock. 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. The
Company'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 the share repurchase program. Microsoft has not paid
cash dividends on its common stock.
Recently Issued Accounting Standards
The Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin
(SAB) 101, Revenue Recognition in Financial Statements, in December 1999. The
SAB summarizes certain of the SEC staff's views in applying U.S. generally
accepted accounting principles to revenue recognition in financial statements.
In June 2000, the SEC issued SAB 101B, which delays the implementation date of
SAB 101 until no later than the fourth fiscal quarter of fiscal years beginning
after December 15, 1999. In October 2000, the SEC issued frequently asked
questions and answers about how the guidance in accounting standards and SAB 101
would apply to particular transactions. The Company does not believe that
adoption of this SAB will have a material impact on its financial statements.
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16
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to foreign currency, interest rate, and securities price
risks. A portion of these risks is hedged, but fluctuations could impact the
Company's results of operations and financial position. The Company hedges the
exposure of accounts receivable and a portion of anticipated revenue to foreign
currency fluctuations, primarily with option contracts. The Company monitors its
foreign currency exposures daily to maximize the overall effectiveness of its
foreign currency hedge positions. Principal currencies hedged include the Euro,
Japanese yen, British pound, and Canadian dollar. Fixed income securities are
subject to interest rate risk. The portfolio is diversified and consists
primarily of investment grade securities to minimize credit risk. The Company
routinely uses options to hedge its exposure to interest rate risk in the event
of a catastrophic increase in interest rates. Many securities held in the
Company's equity and other investments portfolio are subject to price risk. The
Company uses options to hedge its price risk on certain highly volatile equity
securities.
The Company uses a value-at-risk (VAR) model to estimate and quantify its market
risks. The VAR model is not intended to represent actual losses in fair value,
but is used as a risk estimation and management tool. Assumptions applied to the
VAR model at June 30, 2000 and March 31, 2001 include the following: normal
market conditions; Monte Carlo modeling with 10,000 simulated market price
paths; a 97.5% confidence interval; and a 20-day estimated loss in fair value
for each market risk category. Accordingly, 97.5% of the time the estimated 20-
day loss in fair value would be nominal for foreign currency denominated
investments and accounts receivable at June 30, 2000 and March 31, 2001, and
would not exceed $211 million and $355 million at June 30, 2000 and March 31,
2001 for interest-sensitive investments or $1.02 billion and $520 million at
June 30, 2000 and March 31, 2001 for equity securities.
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Part II. Other Information
Item 1. Legal Proceedings
See notes to financial statements.
Item 6. Exhibits and Reports on Form 8-K
(A) Exhibits
None
(B) Reports on Form 8-K
The Company filed no reports on Form 8-K during the quarter ended March 31,
2001.
Items 2, 3, 4, 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: May 15, 2001 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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