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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, 1998
[ ] 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, 1998 was 2,464,072,255.
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MICROSOFT CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 1998
INDEX
Part I. Financial Information
Item 1. Financial Statements Page
----
a) Income Statements
for the Three and Nine Months
Ended March 31, 1997 and 1998...................... 1
b) Balance Sheets
as of June 30, 1997 and March 31, 1998............. 2
c) Cash Flows Statements
for the Nine Months Ended March 31, 1997 and 1998.. 3
d) Notes to Financial Statements...................... 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................... 8
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..................................... 12
Item 6. Exhibits and Reports on Form 8-K...................... 12
SIGNATURE.............................................................. 13
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Part I. Financial Information
ITEM 1. FINANCIAL STATEMENTS
MICROSOFT CORPORATION
INCOME STATEMENTS
(In millions, except earnings per share)(Unaudited)
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<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
Mar. 31 Mar. 31
1997 1998 1997 1998
<S> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------
Revenue $ 3,208 $ 3,774 $ 8,183 $10,489
Operating expenses:
Cost of revenue 297 317 843 883
Research and development 492 597 1,409 1,791
Acquired in-process technology 0 0 0 296
Sales and marketing 750 829 2,112 2,493
General and administrative 101 104 268 305
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Total operating expenses 1,640 1,847 4,632 5,768
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Operating income 1,568 1,927 3,551 4,721
Interest income 119 190 316 489
Other expenses (84) (60) (179) (181)
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Income before income taxes 1,603 2,057 3,688 5,029
Provision for income taxes 561 720 1,291 1,896
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Net income 1,042 1,337 2,397 3,133
Preferred stock dividends 7 7 8 21
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Net income available for common shareholders $ 1,035 $ 1,330 $ 2,389 $ 3,112
==================================================================================================================
Earnings per share(1):
Basic $ 0.43 $ 0.55 $ 1.00 $ 1.29
==================================================================================================================
Diluted $ 0.40 $ 0.50 $ 0.92 $ 1.17
==================================================================================================================
</TABLE>
(1) Earnings per share amounts for the three and nine months ended March 31,
1997 have been restated to reflect a two-for-one stock split in February
1998.
See accompanying notes.
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MICROSOFT CORPORATION
BALANCE SHEETS
(In millions)
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June 30 Mar. 31
1997 1998(1)
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ASSETS
Current assets:
Cash and short-term investments $ 8,966 $12,322
Accounts receivable 980 1,055
Other 427 358
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Total current assets 10,373 13,735
Property, plant, and equipment 1,465 1,416
Equity investments 2,346 4,122
Other assets 203 272
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Total assets $14,387 $19,545
=========================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 721 $ 908
Accrued compensation 336 225
Income taxes payable 466 527
Unearned revenue 1,418 2,463
Other 669 746
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Total current liabilities 3,610 4,869
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Commitments and contingencies
Stockholders' equity:
Convertible preferred stock -
shares authorized 100; outstanding 13 980 980
Common stock and paid-in capital -
shares authorized 8,000; outstanding
2,408 and 2,454 4,509 6,984
Retained earnings 5,288 6,712
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Total stockholders' equity 10,777 14,676
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Total liabilities and stockholders' equity $14,387 $19,545
=========================================================================
(1) Unaudited
See accompanying notes.
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MICROSOFT CORPORATION
CASH FLOWS STATEMENTS
(In millions)(Unaudited)
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Nine Months Ended
Mar. 31
1997 1998
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CASH FLOWS FROM OPERATIONS
Net income $ 2,397 $ 3,133
Depreciation and amortization 414 776
Write-off of acquired
in-process technology 0 296
Unearned revenue 1,054 2,139
Recognition of unearned revenue
from prior periods (353) (1,094)
Other current liabilities 377 266
Accounts receivable (252) (123)
Other current assets (18) 53
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Net cash from operations 3,619 5,446
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CASH FLOWS USED FOR FINANCING
Common stock issued 553 650
Common stock repurchased (3,101) (1,605)
Put warrant proceeds 126 388
Preferred stock issued 980 0
Preferred stock dividends (7) (21)
Stock option income tax benefits 482 910
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Net cash used for financing (967) 322
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CASH FLOWS USED FOR INVESTMENTS
Additions to property,
plant, and equipment (326) (415)
Cash portion of WebTV purchase price 0 (190)
Equity investments and other (155) (1,756)
Short-term investments (895) (2,952)
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Net cash used for investments (1,376) (5,313)
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Net change in cash and equivalents 1,276 455
Effect of exchange rates on
cash and equivalents (25) (51)
Cash and equivalents,
beginning of period 2,601 3,706
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Cash and equivalents, end of period 3,852 4,110
Short-term investments, end of period 5,234 8,212
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Cash and short-term investments,
end of period $9,086 $12,322
==============================================================
See accompanying notes.
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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 and cash flows 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 1997 Form 10-K.
STOCK SPLIT
In February 1998, 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 calculated using the average number of common shares
outstanding. Diluted earnings per share is computed on the basis of the 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 forward purchase arrangements, and outstanding stock options using the
treasury stock method.
Earnings Per Share
(In millions)
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<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
Mar. 31 Mar. 31
1997 1998 1997 1998
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<S> <C> <C> <C> <C>
Net income (A) $1,042 $1,337 $2,397 $3,133
Preferred stock dividends (7) (7) (8) (21)
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Net income available for common shareholders (B) $1,035 $1,330 $2,389 $3,112
======================================================================================================================
Average outstanding:
Common stock (C) 2,389 2,433 2,389 2,421
Common stock under forward purchase arrangements 0 5 0 2
Preferred stock 25 15 9 18
Employee stock options 223 232 212 232
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Common stock and common stock equivalents (D) 2,637 2,685 2,610 2,673
======================================================================================================================
Earnings per share:
Basic (B/C) $ 0.43 $ 0.55 $ 1.00 $ 1.29
======================================================================================================================
Diluted (A/D) $ 0.40 $ 0.50 $ 0.92 $ 1.17
======================================================================================================================
</TABLE>
UNEARNED REVENUE
Microsoft believes that Internet technologies are integral to its products and
has committed to integrating these technologies, such as its browser, Microsoft
Internet Explorer, into existing products at no additional cost to its
customers. Given this strategy and other support commitments such as telephone
support, Internet-based technical support, and unspecified product enhancements,
Microsoft recognizes approximately 20% of Windows operating
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systems revenue over the product life cycles, currently estimated at two years.
The unearned portion of revenue from Windows operating systems was $860 million
at June 30, 1997 and $1.10 billion at March 31, 1998.
Since Office 97 is also tightly integrated with the rapidly evolving Internet,
and in the view of subsequent delivery of new Internet technologies,
enhancements, and other support, a ratable revenue recognition policy became
effective for Office 97 licenses beginning in the third quarter of fiscal 1997.
Approximately 20% of Office 97 revenue is recognized ratably over the estimated
18-month product life cycle. Unearned revenue associated with Office 97 totaled
$300 million at June 30, 1997 and $700 million at March 31, 1998.
Unearned revenue also includes maintenance and other subscription contracts,
including custom enterprise license agreements.
STOCKHOLDERS' EQUITY
Microsoft repurchases its common stock on the open market. This program
provides shares for issuance to employees under the Company's stock option and
stock purchase plans. During the first three quarters of fiscal 1998, the
Company repurchased 7.4 million shares of Microsoft common stock in the open
market. In addition, under agreements with an independent third party, the
Company purchased 21.2 million shares of stock through forward purchase
arrangements. Under these arrangements, a portion of the purchase price will be
paid in the next five or six years and determined based upon the price of
Microsoft common stock at that time. The timing and method of payment (net-
share or cash) is at the discretion of the Company. The difference between the
cash paid and the price of Microsoft common stock on the date of the agreement
is reflected in stockholders' equity.
To enhance its stock repurchase program, Microsoft sells equity put warrants to
independent third parties. These put warrants entitle the purchasers to sell
shares of Microsoft common stock to the Company on certain dates at specified
prices. On March 31, 1998, 46 million warrants were outstanding with strike
prices ranging from $67 to $70 per share. The warrants expire at various dates
between the first quarter of fiscal 1999 and the third quarter of fiscal 2000
and are exercisable only at maturity. These put warrant contracts permit a net-
share settlement at the Company's option, and do not result in a put warrant
liability on the balance sheet.
During December 1996, Microsoft issued 12.5 million shares of 2.75% convertible
exchangeable principal-protected preferred stock. Dividends are payable
quarterly in arrears. Preferred shareholders have preference over common
stockholders in dividends and liquidation rights. In December 1999, each
preferred share is convertible into common shares or an equivalent amount of
cash determined by a formula that provides a floor price of $79.875 and a cap of
$102.24 per preferred share. Net proceeds of $980 million from the issuance
were used to repurchase common shares.
ACQUISITION OF WEBTV
On August 1, 1997, the Company acquired WebTV Networks, Inc. (WebTV), an online
service that enables consumers to experience the Internet through their
televisions via set-top terminals. Microsoft paid $190 million in cash and $235
million of common stock for WebTV. The acquired net working capital of WebTV
was not material. The accompanying income statement reflects a one-time write-
off of in-process technologies under development by WebTV of $296 million.
CONTINGENCIES
On October 7, 1997, Sun Microsystems, Inc. brought suit against Microsoft in the
U.S. District Court for the Northern District of California. On October 14,
1997, Sun filed a First Amended Complaint (Complaint). The 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 alleges:
statutory and contractual trademark claims related to Microsoft's alleged
improper use of the Java Compatibility logo; a false advertising claim related
to statements Microsoft allegedly has made about its Java support and products;
a claim that Microsoft has breached the Agreement in several respects; a claim
that Microsoft allegedly made Sun's source code generally available to the
public; a claim for breach of the covenant of good faith and fair dealing; a
claim for unfair competition; a claim for intentional interference with
contractual relations between Sun and its customers or prospective customers;
and a claim that Microsoft induced software developers to breach their license
agreements with Sun. The Complaint seeks: a preliminary and permanent
injunction against Microsoft distributing certain products with the Java
Compatibility logo, and against distributing Internet Explorer 4.0 unless
certain alleged obligations are met; an order compelling Microsoft to perform
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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 October 27, 1997, Microsoft filed its Answer, Affirmative Defenses, and
Counterclaims (Answer). In its Answer, Microsoft denies Sun's claims, and
denies that Sun is entitled to any relief. Microsoft alleges that Sun agreed to
limit its remedies for all claims such as those alleged in the Complaint to
compensatory damages capped by the total license fees paid ($17.5 million over
the life of the Agreement). Microsoft specifically denies that Sun is entitled
to any injunctive relief. Although the Agreement does provide for liquidated
damages of $35 million if Microsoft makes Sun's Source Code generally available
to the public under certain conditions, Microsoft denies that there is any basis
for such a claim. Microsoft asserts other defenses to each of Sun's claims. In
addition, Microsoft alleges counterclaims against Sun, including claims that:
Sun has breached the Agreement in many respects; Microsoft is entitled to a
court order that Microsoft may terminate Sun's license under the Agreement to
certain Microsoft technology and otherwise determining the parties' rights and
responsibilities; Sun has breached the covenant of good faith and fair dealing;
and Sun has violated California's unfair competition statute. Microsoft also
alleges that it has put Sun on notice of other breaches of contract and that
Microsoft will seek to amend its counterclaim to state additional claims if
those breaches are not timely cured. Microsoft seeks a declaratory judgment
consistent with its claims and seeks compensatory damages consistent with the
limitations in the Agreement. On November 17, 1997, Sun filed a motion for
preliminary injunction seeking to enjoin Microsoft from using the Java
compatibility logo on IE 4.0 during the pendency of the litigation on the basis
that IE 4.0 does not pass certain Java compatibility tests. A hearing on this
motion was held on February 27, 1998. At the hearing, the court set September 4,
1998 as the date on which the court will hear all motions relating to the
interpretation of the parties' agreement.
On March 24, 1998, the court entered an order granting Sun's motion and
enjoining Microsoft from using the Java Compatibility Logo on Internet Explorer
4.0 and Microsoft Software Developers Kit for Java 2.0. Microsoft has taken
steps to fully comply with the order.
On May 12, 1998, Sun filed companion motions seeking a preliminary injunction
based on allegations of copyright infringement and unfair competition. Sun
requested an order enjoining Microsoft from distributing any Java Technology in
any operating system, browser, or developers tools, including Windows 98, IE 4.0
and JV++ 6.0, unless and until Microsoft includes with each such product an
implementation of the Java runtime environment that passes Sun's compatibility
test suite or an operable implementation of Sun's current Java runtime
environment. Sun also filed a motion to amend its complaint to include a claim
of copyright infringement. The new allegation alleges that Microsoft has
infringed Sun's copyrights in the Java Technology because it has used the
technology outside of the scope of the license agreement. The hearing for these
motions is set for July 31, 1998.
The parties are engaged in ongoing discovery in anticipation of the July 31 and
September 4 hearings.
On October 20, 1997, the Antitrust Division of the U.S. Department of Justice
(DOJ) filed a Petition for An Order To Show Cause in United States District
Court for the District of Columbia. The DOJ contends that Microsoft has
violated a consent decree that was entered into by the DOJ and Microsoft on
July 15, 1994, and approved by the Court on August 18, 1995, to conclude an
earlier investigation by the DOJ. In its petition, the DOJ contends that
Microsoft has violated the consent decree by including Internet Explorer
technology in Windows 95, and by preventing original equipment manufacturers
(OEMs) from removing Internet Explorer functionality from versions of Windows 95
the OEMs are licensed to install on computer systems they sell. In addition, the
DOJ alleges that certain non-disclosure agreements between Microsoft and its
customers prohibiting the release of confidential information without prior
notice to the other party are impairing the DOJ's ability to enforce the consent
decree. The DOJ's petition seeks an order from the Court requiring Microsoft to
demonstrate that it has not violated the consent decree. Microsoft does not
believe it has violated the consent decree and intends to vigorously contest
this lawsuit.
On December 5, 1997, Judge Jackson heard oral argument on the DOJ's contempt
petition. On December 11, 1997, the court entered two orders. In the first
order, Judge Jackson denied the DOJ's contempt petition, and dismissed the DOJ's
request for relief concerning Microsoft's non-disclosure agreements because the
DOJ had failed to present evidence that the agreements had interfered with any
DOJ investigation. In addition, however, the court ruled that there were
disputed issues of fact regarding Microsoft's violation of the consent decree,
and concluded that the DOJ was likely to prevail on its claim that a violation
had occurred. The court entered a preliminary injunction sua sponte requiring
Microsoft not to condition the licensing of Windows 95 or any successor desktop
operating system on a computer manufacturer also licensing any Microsoft browser
software, including Internet Explorer 3.0 or 4.0. In the second order, the
court appointed Harvard Law Professor Lawrence Lessig as a special master, to
whom the court delegated the authority to conduct discovery, take evidence, and
make proposed findings of fact and conclusions of law on all issues in the case
by May 31, 1998.
Microsoft immediately appealed the preliminary injunction to the District of
Columbia Circuit Court of Appeals and sought an expedited hearing on the grounds
that there are substantial grounds for challenging Judge Jackson's order and
that Microsoft will incur irreparable harm if the appeal is not heard quickly.
The DOJ opposed expedited treatment. On December 30, 1997, the Court of Appeals
entered an order granting Microsoft's motion and set a schedule pursuant to
which oral argument was heard on April 21, 1998.
On December 23, 1997, Microsoft filed a motion in the District Court to revoke
the reference to a special master on the grounds that improper procedure was
used and that the scope of the reference was impermissibly broad. In addition,
Microsoft raised concerns about the impartiality of Professor Lessig based upon
statements in some of his writings. On January 15, 1998 the District Court
denied Microsoft's motion and refused to certify its ruling for appeal. On
January 16, 1998 Microsoft filed a petition for mandamus in the District of
Columbia Circuit Court of Appeals, seeking
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a stay of all proceedings by the special master until the Court of Appeals could
rule, and seeking an order reversing the reference to the special master. On
February 2, 1998 the Court of Appeals ordered that the petition for mandamus
would be consolidated with the pending appeal and oral argument heard on April
21, 1998. The Court also stayed all proceedings before the special master until
it rules on the petition.
The case was heard by a panel of the Court of Appeals on April 21, 1998. The
Court has not yet ruled on the matters argued. On May 5, 1998, Microsoft also
sought a stay of the District Court's injunction insofar as it applied to
Windows 98. On May 12, 1998 the Court of Appeals granted Microsoft's request
for a stay.
In other ongoing investigations, the DOJ and sixteen state Attorneys General
have requested information from Microsoft concerning various issues. The DOJ and
a group of approximately 19 state Attorneys General have threatened to file an
antitrust case against Microsoft. The parties are currently exploring whether a
negotiated resolution can be reached. If it cannot, management believes it is
likely that a lawsuit will be filed, but it is impossible at this time to
determine its scope or outcome. We do not believe such an action would include
significant claims for damages against Microsoft.
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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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
Microsoft develops, manufactures, licenses, sells, and supports a wide range of
software products, including scalable operating systems for information
appliances, personal computers (PCs), and servers; server applications for
client/server environments; business and consumer productivity applications;
software development tools; and Internet and intranet software and technologies.
The Company's interactive content efforts include entertainment and information
software programs, MSN(TM), the Microsoft Network online service, Internet-based
services, and alliances with companies involved with other forms of digital
interactivity. Microsoft also sells personal computer input devices and books,
and researches and develops advanced technologies for future software products.
REVENUE
Revenue of $3.77 billion in the third quarter of fiscal 1998 increased 18% over
the third quarter of fiscal 1997. On a year to date basis, revenue increased
28% from the prior year to $10.49 billion. The growth rate, although slower
than that of recent quarters, reflected the continued adoption of Windows(R) 32-
bit operating systems and Microsoft Office 97, particularly as Microsoft
software is deployed across entire organizations. 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 OEM licenses and
organization license programs, such as Microsoft Select, is lower than average
revenue per license from retail versions. Likewise, product upgrades have lower
prices than new products. Also, prices of integrated suites, such as Microsoft
Office, are less than the sum of the prices for the individual programs included
in these suites when such programs are licensed separately. Microsoft
recognizes a portion of Windows operating systems revenue over the products'
life cycles. This revenue recognition policy was extended to Office 97 licenses
in the third quarter of fiscal 1997. (See notes to financial statements.)
PRODUCT GROUPS
Platforms product revenue grew 17% to $1.97 billion in the third quarter,
compared to $1.68 billion in the comparable quarter of the prior year. Year to
date Platforms revenue was $5.55 billion in fiscal 1998 and $4.35 billion in
fiscal 1997. Platforms product group revenue is primarily licenses of PC
operating systems; business systems with client/server, Internet, and intranet
architectures; and software development tools.
Windows 95 units licensed through the OEM channel increased strongly over the
comparable quarter of the prior year. Revenue from retail versions of Windows 95
decreased as finished goods distributors and resellers reduced channel inventory
levels in anticipation of Windows 98. Additionally, revenue from the Microsoft
Windows NT(R) Workstation operating system showed healthy growth. The revenue
growth rate for Microsoft BackOffice(R) server and server applications products
continued to slow from the rapid rates experienced in prior periods.
Applications and Content product revenue increased 18% to $1.81 billion in the
March quarter. For the first three quarters of fiscal 1998, revenue was $4.94
billion, compared to $3.83 billion the prior year. Applications and Content
product group revenue includes primarily licenses of desktop and consumer
productivity applications, interactive media programs, and PC input devices. The
various Microsoft Office integrated suites, including the Standard,
Professional, and Small Business Editions, generate most desktop application
revenue. The primary programs in Microsoft Office are Microsoft Word word
processor, Microsoft Excel spreadsheet, and Microsoft PowerPoint(R) presentation
graphics program. Various versions of Office, which are available for Windows
32-bit, Windows 16-bit, and Macintosh operating systems, also include
applications such as Microsoft Access database management program, Microsoft
Outlook(TM) desktop manager, Microsoft Schedule+ calendar and scheduling
program, and an email client license.
Revenue from integrated suites increased strongly, while stand-alone versions of
Microsoft Excel, Microsoft Word, and Microsoft PowerPoint continued to decrease.
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SALES CHANNELS
Microsoft distributes its products primarily through OEM licenses,
organizational licenses, and retail packaged products. OEM channel revenue
represents license fees from original equipment manufacturers who pre-install
Microsoft products, primarily on PCs. Microsoft has three major geographic
sales and marketing organizations: the U.S. and Canada, Europe, and elsewhere in
the world (Other International). Sales of organization licenses and packaged
products in these channels are primarily to distributors and resellers. The
trend has continued toward a higher percentage of organizational licensing
versus packaged products.
Revenue from the OEM channel in the March quarter of $1.23 billion was flat
with the second quarter, and up 28% over the prior year. Year to date, OEM
revenue was $3.43 billion compared to $2.49 billion the prior year. The primary
source of OEM revenue is the licensing of desktop operating systems. Greater PC
shipments, although at a slowing growth rate, coupled with an increased
penetration of higher value 32-bit PC operating systems drove the OEM revenue
increase over the prior year.
For the third fiscal quarter, finished goods revenue in the U.S. and Canada
increased 18% to $1.11 billion from $938 million the prior year. Year to date
revenue of $3.07 billion grew 22% over the prior year. The growth rate in the
U.S. and Canada reflected slowing growth of business systems and declining
shipments and licensing of retail versions of the Windows 95 operating system.
Desktop applications increased over the comparable quarter due to strong
licensing of Microsoft Office and Office Professional. Microsoft Office 98
Macintosh Edition was released during the quarter in the U.S.
Third quarter revenue of $849 million in Europe was steady with the immediately
prior quarter, but increased only 6% compared to the third quarter of fiscal
1997. Growth rates slowed across most product lines. As discussed below, the
strengthening U.S. dollar negatively impacted translated European revenue
compared to the third quarter of the prior year. Year to date revenue of $2.33
billion grew 26% over the prior year.
Other International channel revenue in the March quarter was $582 million, an
increase of 14% compared to $511 million the prior year. The third quarter
growth rate was lower than recent quarters due to declining sales in Japan and
Southeast Asia, which partially offset solid growth in Mexico, Brazil, and other
South American countries. Year to date revenue was $1.66 billion in fiscal 1998
and $1.33 billion in fiscal 1997. Key drivers of growth were increased
organizational licensing of Microsoft Office and sales of BackOffice packaged
product.
Translated international revenue is effected by foreign exchange rates. Had the
rates from the prior year been in affect in the third quarter, European revenue
would have been $80 million higher. Additionally, other international revenue
billed in local currencies, principally in Japan, suffered a $46 million drag
due to weaknesses in currencies versus the U.S. dollar. Certain manufacturing,
selling, distribution, and support costs are disbursed in local currencies, and
a portion of international revenue is hedged, thus offsetting a portion of the
translation exposure.
OPERATING EXPENSES, NONOPERATING ITEMS, AND INCOME TAXES
Cost of revenue as a percent of revenue declined to 8.4% in the third quarter
from 9.3% the prior year. For the first three quarters of fiscal 1998, cost of
revenue as a percent of revenue was 8.4% compared to 10.3% in fiscal 1997. The
decrease was due to the shifts in mix to CD-ROMs (which carry lower cost of
goods than disks), licenses to OEMs and organizations, and higher-margin Windows
NT Server and other BackOffice server products.
Research and development expenses increased 21% in the third quarter to $597
million and increased 27% year to date to $1.79 billion, primarily driven by
higher development headcount-related costs and third party development.
On August 1, 1997, the Company acquired WebTV Networks, Inc. (WebTV), an online
service that enables consumers to experience the Internet through their
televisions via set-top terminals. Microsoft paid $425 million in stock and
cash for WebTV. The accompanying income statement reflects a one-time write-off
of in-process technologies under development by WebTV of $296 million.
Sales and marketing expenses were $829 million in the third quarter of fiscal
1998, which represented 22.0% of revenue, compared to 23.4% in the third quarter
of the prior year. On a year to date basis, sales and marketing expenses of
$2.49 billion represented 23.8% of revenue, compared to 25.8% in fiscal 1997.
The total expense as a percent of revenue decreased due to lower relative sales
expenses.
General and administrative costs were $104 million in the third quarter compared
to $101 million in the comparable quarter of the prior year. In the first three
quarters of fiscal 1998, general and administrative expenses were $305 million,
compared to costs of $268 million the prior year.
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Interest income increased as a result of a larger investment portfolio generated
by cash from operations. Other expenses include primarily the recognition of
the Company's share of joint venture activities, including DreamWorks
Interactive and the MSNBC entities.
The effective tax rate for the March quarter was 35%, a one-point decrease from
the first half of fiscal 1998 due to a legislative clarification of the foreign
sales corporation rules as they apply to software. On a year to date basis, the
effective income tax rate increased due to the nondeductibility of the write-off
of the WebTV in-process technologies and amortization of other WebTV intangible
assets.
NET INCOME
Net income for the third quarter of fiscal 1998 was $1.34 billion. On a year to
date basis, net income was 29.9% of revenue in fiscal 1998 compared to 29.3% the
prior year. Excluding the one-time write-off of WebTV in-process R&D, net
income represented 32.7% of revenue in the first three quarters of fiscal 1998.
Earnings per share without the write-off were $1.28, a 39% increase compared to
the $0.92 earned during the same period the prior year.
FINANCIAL CONDITION
Microsoft's cash and short-term investment portfolio totaled $12.32 billion at
March 31, 1998. 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 includes
short-term securities to minimize interest rate risk and facilitate rapid
deployment in the event of immediate cash needs.
During 1996, Microsoft and National Broadcasting Company (NBC) established two
joint ventures: a 24-hour cable news and information channel and an interactive
online news service. Microsoft agreed to pay $220 million over a five-year
period for its interest in the cable venture and to pay one-half of operational
funding of both joint ventures for a multiyear period.
Microsoft has no material long-term debt and has $100 million of standby
multicurrency lines of credit to support foreign currency hedging and cash
management. Stockholders' equity at March 31, 1998 was $14.68 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 and to fund ventures and other 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
March 31, 1998.
Cash will also be used to repurchase common stock to provide shares for employee
stock option and purchase plans. Despite recent increases in stock repurchases,
the buyback program has not kept pace with employee stock option grants or
exercises. Beginning in fiscal 1990, Microsoft has repurchased 337 million
common shares for $7.8 billion while 781 million shares were issued under the
Company's employee stock option and purchase plans. The market value of all
outstanding stock options was $42.2 billion as of March 31, 1998. Microsoft
enhances its repurchase program by selling put warrants. During December 1996,
Microsoft issued 12.5 million shares of 2.75% convertible preferred stock. Net
proceeds of $980 million were used to repurchase common shares.
Management currently believes existing cash and short-term investments together
with funds generated from operations will be sufficient to meet operating
requirements for the next 12 months. Microsoft's cash and short-term
investments are available for strategic investments, mergers and acquisitions,
other potential large-scale cash needs that may arise, and to fund the
continuation of its stock buyback program to reduce the dilutive impact of the
Company's employee stock option and purchase programs.
Microsoft has not paid cash dividends on its common stock. The preferred stock
pays $2.196 per annum per share.
YEAR 2000
The year 2000 poses certain issues for business and consumer computing,
particularly the functionality of software for two-digit storage of dates and
special meanings for certain dates such as 9/9/99. The year 2000 is also a leap
year, which may also lead to incorrect calculations, functions, or system
failure. The problem exists for many kinds of software, including software for
mainframes, PCs, and embedded systems. Microsoft is in the process of
gathering, testing, and producing information about Microsoft technologies
impacted by Year 2000 transition. Current information about the Company's
products and business and technical concerns is available at the Microsoft
- --------------------------------------------------------------------------------
10
<PAGE>
Year 2000 Resource Center web site (www.microsoft.com/year2000). The web site
also contains information about obtaining software patches to resolve various
Year 2000 issues in certain Microsoft products. The Company's Year 2000 strategy
for its products is as follows:
Definitions. First, Microsoft will classify its products into categories of
compliance: compliant, compliant with minor issues, not-compliant, testing yet
to be completed, and will not test.
Next steps to compliance. Second, if a product is stated to be non-compliant,
Microsoft will provide information as to how an organization could bring that
product into compliance.
Provide components for solutions. Third, Microsoft will help organizations find
solutions to Year 2000 problems. The technologies and services offered by
Microsoft and its partners will be components in overall Year 2000 solutions.
Microsoft will assist companies with the task of recognizing how disparate
technologies can fit together to create a viable solution set.
Information on the Company's web site is provided to customers for the sole
purpose of assisting the planning for the transition to the year 2000. Such
information is the most currently available concerning the behavior of the
Company's products in the next century and is provided "as is" without warranty
of any kind. However, variability of definitions of "compliance" with the Year
2000 and of different combinations of software, firmware, and hardware will
likely lead to lawsuits against the Company. The outcomes of such lawsuits and
the impact on the Company are not estimable at this time.
The Year 2000 issue also affects the Company's internal systems. Microsoft is
assessing the readiness of its systems and those of its vendors, distributors,
and resellers for handling the year 2000. Although the assessment is still
underway, 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.
Resolving Year 2000 issues is a worldwide phenomenon that will likely absorb a
substantial portion of Information Technology (IT) budgets and attention in the
near term. Certain industry analysts believe the Year 2000 issue will
accelerate the trend toward distributed PC-based systems from mainframe systems,
while others believe a majority of IT resources will be devoted to fixing older
mainframe software in lieu of large scale transitions to systems based on
software such as that sold by Microsoft. The impact of the year 2000 on future
Microsoft revenue is difficult to discern but is a risk to be considered in
evaluating future growth of the Company.
- --------------------------------------------------------------------------------
11
<PAGE>
Part II. Other Information
ITEM 1. LEGAL PROCEEDINGS
See notes to financial statements.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
27. Financial Data Schedule
(B) REPORTS ON FORM 8-K
Microsoft filed no reports on Form 8-K during the quarter ended
March 31, 1998.
ITEMS 2, 3, 4, AND 5 ARE NOT APPLICABLE AND HAVE BEEN OMITTED.
- --------------------------------------------------------------------------------
12
<PAGE>
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 14, 1998 By: /s/ Gregory B. Maffei
-----------------------
Gregory B. Maffei,
Vice President, Finance;
Chief Financial Officer
(Principal Financial and Accounting Officer
and Duly Authorized Officer)
- --------------------------------------------------------------------------------
13
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
ACCOMPANYING FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-END> MAR-31-1998
<CASH> 12,322
<SECURITIES> 0
<RECEIVABLES> 1,055
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 13,735
<PP&E> 3,055
<DEPRECIATION> 1,639
<TOTAL-ASSETS> 19,545
<CURRENT-LIABILITIES> 4,869
<BONDS> 0
0
980
<COMMON> 6,984
<OTHER-SE> 6,712
<TOTAL-LIABILITY-AND-EQUITY> 19,545
<SALES> 10,489
<TOTAL-REVENUES> 10,489
<CGS> 883
<TOTAL-COSTS> 883
<OTHER-EXPENSES> 4,885
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 5,029
<INCOME-TAX> 1,896
<INCOME-CONTINUING> 3,133
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,133
<EPS-PRIMARY> 1.29
<EPS-DILUTED> 1.17
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
ACCOMPANYING FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<S> <C> <C>
<PERIOD-TYPE> 6-MOS 3-MOS
<FISCAL-YEAR-END> JUN-30-1998 JUN-30-1998
<PERIOD-END> DEC-31-1997 SEP-30-1997
<CASH> 10,105 9,634
<SECURITIES> 0 0
<RECEIVABLES> 1,081 788
<ALLOWANCES> 0 0
<INVENTORY> 0 0
<CURRENT-ASSETS> 11,636 10,838
<PP&E> 2,923 2,800
<DEPRECIATION> 1,445 1,316
<TOTAL-ASSETS> 16,840 15,366
<CURRENT-LIABILITIES> 4,496 3,902
<BONDS> 0 0
0 0
980 980
<COMMON> 6,104 5,630
<OTHER-SE> 5,260 4,854
<TOTAL-LIABILITY-AND-EQUITY> 16,840 15,366
<SALES> 6,715 3,130
<TOTAL-REVENUES> 6,715 3,130
<CGS> 566 253
<TOTAL-COSTS> 566 253
<OTHER-EXPENSES> 3,355 1,746
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 0 0
<INCOME-PRETAX> 2,972 1,202
<INCOME-TAX> 1,176 539
<INCOME-CONTINUING> 1,796 663
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 1,796 663
<EPS-PRIMARY> .74<F1> 0.27<F1>
<EPS-DILUTED> .67<F1> 0.25<F1>
<FN>
<F1>THIS STATEMENT HAS BEEN RESTATED AS A RESULT OF SFAS 128, EARNINGS PER
SHARE, AND APPLICABLE STOCK SPLITS.
</FN>
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
ACCOMPANYING FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<S> <C> <C> <C> <C>
<PERIOD-TYPE> YEAR 9-MOS 6-MOS 3-MOS
<FISCAL-YEAR-END> JUN-30-1997 JUN-30-1997 JUN-30-1997 JUN-30-1997
<PERIOD-END> JUN-30-1997 MAR-31-1997 DEC-31-1996 SEP-30-1996
<CASH> 8,966 9,086 9,160 7,098
<SECURITIES> 0 0 0 0
<RECEIVABLES> 980 866 975 855
<ALLOWANCES> 0 0 0 0
<INVENTORY> 0 0 0 0
<CURRENT-ASSETS> 10,373 10,224 10,442 8,232
<PP&E> 2,777 2,604 2,512 2,404
<DEPRECIATION> 1,312 1,233 1,190 1,100
<TOTAL-ASSETS> 14,387 12,613 12,786 10,740
<CURRENT-LIABILITIES> 3,610 3,479 3,144 2,663
<BONDS> 0 0 0 0
0 0 0 0
980 980 980 0
<COMMON> 4,509 4,036 3,541 3,220
<OTHER-SE> 5,288 4,118 5,121 4,057
<TOTAL-LIABILITY-AND-EQUITY> 14,387 12,613 12,786 10,740
<SALES> 11,358 8,183 4,975 2,295
<TOTAL-REVENUES> 11,358 8,183 4,975 2,295
<CGS> 1,085 843 546 250
<TOTAL-COSTS> 1,085 843 546 250
<OTHER-EXPENSES> 5,143 3,789 2,446 1,143
<LOSS-PROVISION> 0 0 0 0
<INTEREST-EXPENSE> 0 0 0 0
<INCOME-PRETAX> 5,314 3,688 2,085 945
<INCOME-TAX> 1,860 1,291 730 331
<INCOME-CONTINUING> 3,439 2,397 1,355 614
<DISCONTINUED> 0 0 0 0
<EXTRAORDINARY> 0 0 0 0
<CHANGES> 0 0 0 0
<NET-INCOME> 3,439 2,397 1,355 614
<EPS-PRIMARY> 1.44<F1> 1.00<F1> .57<F1> 0.26<F1>
<EPS-DILUTED> 1.32<F1> .92<F1> .52<F1> 0.24<F1>
<FN>
<F1>THIS STATEMENT HAS BEEN RESTATED AS A RESULT OF SFAS 128, EARNINGS PER
SHARE, AND APPLICABLE STOCK SPLITS.
</FN>
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
ACCOMPANYING FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<S> <C> <C> <C> <C>
<PERIOD-TYPE> YEAR 9-MOS 6-MOS 3-MOS
<FISCAL-YEAR-END> JUN-30-1996 JUN-30-1996 JUN-30-1996 JUN-30-1996
<PERIOD-END> JUN-30-1996 MAR-31-1996 DEC-31-1995 SEP-30-1995
<CASH> 6,940 6,770 6,017 5,064
<SECURITIES> 0 0 0 0
<RECEIVABLES> 639 681 771 1,208
<ALLOWANCES> 0 0 0 156
<INVENTORY> 0 33 108 125
<CURRENT-ASSETS> 7,839 7,696 7,103 6,417
<PP&E> 2,346 2,201 2,080 1,944
<DEPRECIATION> 1,020 920 783 679
<TOTAL-ASSETS> 10,093 9,590 9,106 8,160
<CURRENT-LIABILITIES> 2,425 2,264 2,241 1,759
<BONDS> 0 0 0 0
0 0 0 0
0 0 0 0
<COMMON> 2,924 2,678 2,285 2,172
<OTHER-SE> 3,984 3,917 3,895 3,567
<TOTAL-LIABILITY-AND-EQUITY> 10,093 9,590 9,106 8,160
<SALES> 8,671 6,416 4,211 2,016
<TOTAL-REVENUES> 8,671 6,416 4,211 2,016
<CGS> 1,188 947 652 322
<TOTAL-COSTS> 1,188 947 652 1,287
<OTHER-EXPENSES> 4,405 3,201 2,065 4
<LOSS-PROVISION> 0 0 0 21
<INTEREST-EXPENSE> 0 0 0 0
<INCOME-PRETAX> 3,379 2,519 1,655 770
<INCOME-TAX> 1,184 883 581 271
<INCOME-CONTINUING> 2,195 1,636 1,074 499
<DISCONTINUED> 0 0 0 0
<EXTRAORDINARY> 0 0 0 0
<CHANGES> 0 0 0 0
<NET-INCOME> 2,195 1,636 1,074 499
<EPS-PRIMARY> .92<F1> .69<F1> .45<F1> 0.21<F1>
<EPS-DILUTED> .86<F1> .64<F1> .42<F1> 0.19<F1>
<FN>
<F1>THIS STATEMENT HAS BEEN RESTATED AS A RESULT OF SFAS 128, EARNINGS PER
SHARE, AND APPLICABLE STOCK SPLITS.
</FN>
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<RESTATED>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1995
<PERIOD-END> JUN-30-1995
<CASH> 4,750
<SECURITIES> 0
<RECEIVABLES> 720
<ALLOWANCES> 139
<INVENTORY> 88
<CURRENT-ASSETS> 5,620
<PP&E> 1,907
<DEPRECIATION> 715
<TOTAL-ASSETS> 7,210
<CURRENT-LIABILITIES> 1,347
<BONDS> 0
0
0
<COMMON> 2,005
<OTHER-SE> 3,328
<TOTAL-LIABILITY-AND-EQUITY> 7,210
<SALES> 5,937
<TOTAL-REVENUES> 5,937
<CGS> 877
<TOTAL-COSTS> 3,848
<OTHER-EXPENSES> 16
<LOSS-PROVISION> 51
<INTEREST-EXPENSE> 2
<INCOME-PRETAX> 2,167
<INCOME-TAX> 714
<INCOME-CONTINUING> 1,453
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,453
<EPS-PRIMARY> .62<F1>
<EPS-DILUTED> .58<F1>
<FN>
<F1>THIS STATEMENT HAS BEEN RESTATED AS A RESULT OF SPAS 128, EARNINGS PER
SHARE, AND APPLICABLE STOCK SPLITS.
</FN>
</TABLE>
