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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2000
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From _____ to ____
-----------------------
Commission File Number 0-14278
MICROSOFT CORPORATION
(Exact name of registrant as specified in its charter)
Washington 91-1144442
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Microsoft Way, Redmond, Washington 98052-6399
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (425) 882-8080
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
The number of shares outstanding of the registrant's common stock as of April
30, 2000 was 5,262,405,409.
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<PAGE>
MICROSOFT CORPORATION
FORM 10-Q
For the Quarter Ended March 31, 2000
INDEX
Part I. Financial Information
Item 1. Financial Statements Page
----
a) Income Statements
for the Three and Nine Months Ended March 31, 1999 and 2000.. 1
b) Balance Sheets
as of June 30, 1999 and March 31, 2000....................... 2
c) Cash Flows Statements
for the Nine Months Ended March 31, 1999 and 2000............ 3
d) Stockholders' Equity Statements
for the Three and Nine Months Ended March 31, 1999 and 2000.. 4
e) Notes to Financial Statements................................ 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.......................... 10
Part II. Other Information
Item 1. Legal Proceedings............................................ 14
Item 6. Exhibits and Reports on Form 8-K............................. 14
Signature.................................................................. 15
<PAGE>
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
1999 2000 1999 2000
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenue $4,595 $5,656 $13,983 $17,152
Operating expenses:
Cost of revenue 708 752 2,145 2,220
Research and development 664 990 2,030 2,735
Sales and marketing 849 1,042 2,331 2,972
General and administrative 144 176 392 825
Other expenses (income) 1 (32) 60 (13)
- ---------------------------------------------------------------------------------------------------------------
Total operating expenses 2,366 2,928 6,958 8,739
- ---------------------------------------------------------------------------------------------------------------
Operating income 2,229 2,728 7,025 8,413
Investment income 720 885 1,318 2,055
Gains on sales 0 0 160 156
- ---------------------------------------------------------------------------------------------------------------
Income before income taxes 2,949 3,613 8,503 10,624
Provision for income taxes 1,032 1,228 2,920 3,612
- ---------------------------------------------------------------------------------------------------------------
Net income $1,917 $2,385 $ 5,583 $ 7,012
===============================================================================================================
Earnings per share:
Basic $ 0.38 $ 0.46 $ 1.11 $ 1.35
===============================================================================================================
Diluted $ 0.35 $ 0.43 $ 1.02 $ 1.27
===============================================================================================================
</TABLE>
See accompanying notes.
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1
<PAGE>
MICROSOFT CORPORATION
Balance Sheets
(In millions)
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<TABLE>
<CAPTION>
June 30 Mar. 31
1999 2000 (1)
- -------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Current assets:
Cash and short-term investments $17,236 $21,205
Accounts receivable 2,245 2,902
Other 752 1,110
- -------------------------------------------------------------------------------------
Total current assets 20,233 25,217
Property and equipment 1,611 1,835
Equity and other investments 14,372 21,322
Other assets 940 2,521
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Total assets $37,156 $50,895
=====================================================================================
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 874 $ 1,073
Accrued compensation 396 373
Income taxes payable 1,607 1,931
Unearned revenue 4,239 4,459
Other 1,602 3,267
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Total current liabilities 8,718 11,103
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Commitments and contingencies
Stockholders' equity:
Convertible preferred stock -
shares authorized 100; outstanding 13 and 0 980 0
Common stock and paid-in capital -
shares authorized 12,000; outstanding 5,109 and 5,242 13,844 20,975
Retained earnings 13,614 18,817
- -------------------------------------------------------------------------------------
Total stockholders' equity 28,438 39,792
- -------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $37,156 $50,895
=====================================================================================
(1) Unaudited
</TABLE>
See accompanying notes.
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2
<PAGE>
MICROSOFT CORPORATION
Cash Flows Statements
(In millions)(Unaudited)
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<TABLE>
<CAPTION>
Nine Months Ended
1999 2000
- --------------------------------------------------------------------------------------
<S> <C> <C>
Operations
Net income $ 5,583 $ 7,012
Depreciation and amortization 514 1,040
Gains on sales (160) (156)
Unearned revenue 4,139 4,278
Recognition of unearned revenue from prior periods (2,832) (4,058)
Other current liabilities 471 (823)
Accounts receivable (192) (558)
Other current assets (104) (328)
- --------------------------------------------------------------------------------------
Net cash from operations 7,419 6,407
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Financing
Common stock issued 1,102 1,750
Common stock repurchased (1,527) (4,872)
Put warrant proceeds 757 472
Preferred stock dividends (21) (13)
Stock option income tax benefits 2,238 4,002
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Net cash from financing 2,549 1,339
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Investing
Additions to property and equipment (291) (617)
Cash proceeds from sale of Softimage, Inc. 79 0
Purchases of investments (20,556) (29,244)
Maturities of investments 3,175 3,086
Sales of investments 9,950 19,182
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Net cash used for investing (7,643) (7,593)
- --------------------------------------------------------------------------------------
Net change in cash and equivalents 2,325 153
Effect of exchange rates on cash and equivalents 39 64
Cash and equivalents, beginning of period 3,839 4,975
- --------------------------------------------------------------------------------------
Cash and equivalents, end of period 6,203 5,192
Short-term investments, end of period 15,558 16,013
- --------------------------------------------------------------------------------------
Cash and short-term investments, end of period $21,761 $21,205
======================================================================================
</TABLE>
See accompanying notes.
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3
<PAGE>
MICROSOFT CORPORATION
Stockholders' Equity Statements
(In millions)(Unaudited)
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<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
Mar. 31 Mar. 31
1999 2000 1999 2000
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Convertible preferred stock
Balance, beginning of period $ 980 $ 0 $ 980 $ 980
Conversion of preferred to common stock 0 0 0 (980)
- ---------------------------------------------------------------------------------------------------------
Balance, end of period 980 0 980 0
- ---------------------------------------------------------------------------------------------------------
Common stock and paid-in capital
Balance, beginning of period 10,443 18,878 8,025 13,844
Common stock issued 901 751 1,771 2,843
Common stock repurchased (20) (20) (45) (186)
Structured repurchases price differential (328) 0 (328) 0
Proceeds from sale of put warrants 402 0 757 472
Stock option income tax benefits 1,020 1,366 2,238 4,002
- ---------------------------------------------------------------------------------------------------------
Balance, end of period 12,418 20,975 12,418 20,975
- ---------------------------------------------------------------------------------------------------------
Retained earnings
Balance, beginning of period 11,155 15,711 7,622 13,614
- ---------------------------------------------------------------------------------------------------------
Net income 1,917 2,385 5,583 7,012
Net unrealized investments gains 46 583 586 2,724
Translation adjustments and other (52) 138 54 166
- ---------------------------------------------------------------------------------------------------------
Comprehensive income 1,911 3,106 6,223 9,902
Preferred stock dividends (7) 0 (21) (13)
Common stock repurchased (735) 0 (1,500) (4,686)
- ---------------------------------------------------------------------------------------------------------
Balance, end of period 12,324 18,817 12,324 18,817
- ---------------------------------------------------------------------------------------------------------
Total stockholders' equity $25,722 $39,792 $25,722 $39,792
=========================================================================================================
</TABLE>
See accompanying notes.
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4
<PAGE>
MICROSOFT CORPORATION
Notes to Financial Statements
(Unaudited)
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Basis of Presentation
In the opinion of management, the accompanying balance sheets and related
interim statements of income, cash flows, and stockholders' equity include all
adjustments (consisting only of normal recurring items) necessary for their fair
presentation in conformity with generally accepted accounting principles.
Preparing financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenue,
and expenses. Examples include provisions for returns and bad debts and the
length of product life cycles and buildings' lives. Actual results may differ
from these estimates. Interim results are not necessarily indicative of results
for a full year. The information included in this Form 10-Q should be read in
conjunction with Management's Discussion and Analysis and financial statements
and notes thereto included in the Microsoft Corporation 1999 Form 10-K.
Earnings Per Share
Basic earnings per share is computed on the basis of the weighted average number
of common shares outstanding. Diluted earnings per share is computed on the
basis of the weighted average number of common shares outstanding plus the
effect of outstanding preferred shares using the "if-converted" method, assumed
net-share settlement of common stock structured repurchases, and outstanding
stock options using the "treasury stock" method.
The components of basic and diluted earnings per share were as follows:
Earnings Per Share
(In millions, except earnings per share)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
Mar. 31 Mar. 31
1999 2000 1999 2000
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income (A) $1,917 $2,385 $5,583 $7,012
Preferred stock dividends (7) 0 (21) (13)
- ------------------------------------------------------------------------------------------------------------
Net income available for common shareholders (B) $1,910 $2,385 $5,562 $6,999
============================================================================================================
Average outstanding shares of common stock (C) 5,055 5,209 5,004 5,167
Dilutive effect of:
Common stock under structured repurchases 12 0 17 0
Preferred stock 16 0 20 9
Employee stock options 429 334 428 360
- ------------------------------------------------------------------------------------------------------------
Common stock and common stock equivalents (D) 5,512 5,543 5,469 5,536
============================================================================================================
Earnings per share:
Basic (B/C) $ 0.38 $ 0.46 $ 1.11 $ 1.35
============================================================================================================
Diluted (A/D) $ 0.35 $ 0.43 $ 1.02 $ 1.27
============================================================================================================
</TABLE>
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5
<PAGE>
Unearned Revenue
A portion of Microsoft's revenue is earned ratably over the product life cycle
or, in the case of subscriptions, over the period of the license agreement.
End users receive certain elements of the Company's products over a period of
time. These elements include browser technologies and technical support.
Consequently, Microsoft's earned revenue reflects the recognition of the fair
value of these elements over the product's life cycle. The percentage of revenue
recognized ratably ranges from approximately 15% to 25% of Windows desktop
operating systems and approximately 10% to 20% of desktop applications,
depending on the terms and conditions of the license and prices of the elements.
Product life cycles are currently estimated at three years for Windows operating
systems and 18 months for desktop applications. The Company also sells
subscriptions to certain products via maintenance and certain organization
license agreements. At March 31, 2000, unearned revenue was $4.46 billion.
Windows Platforms products unearned revenue was $2.49 billion and unearned
revenue associated with Productivity Applications and Developer products totaled
$1.78 billion. Unearned revenue for other miscellaneous programs totaled $191
million.
Stockholders' Equity
During the first three quarters of fiscal 2000, the Company repurchased 54.7
million shares of Microsoft common stock in the open market. In January 2000,
the Company announced the termination of its stock buyback program.
To enhance its stock repurchase program, Microsoft sold put warrants to
independent third parties. These put warrants entitle the holders to sell shares
of Microsoft common stock to the Company on certain dates at specified prices.
On March 31, 2000, 163 million warrants were outstanding with strike prices
ranging from $69 to $78 per share. The put warrants expire between June 2000 and
December 2002. The outstanding put warrants permit a net-share settlement at the
Company's option and do not result in a put warrant liability on the balance
sheet.
During 1996, Microsoft issued 12.5 million shares of 2.75% convertible
exchangeable principal-protected preferred stock. Net proceeds of $980 million
were used to repurchase common shares. The Company's convertible preferred stock
matured on December 15, 1999. Each preferred share was converted into 1.1273
common shares.
Operational Transactions
In January 2000, the Company merged with Visio Corporation in a transaction that
was accounted for as a pooling of interests. Microsoft issued 14 million shares
in exchange for the outstanding stock of Visio. Visio's assets and liabilities,
which were nominal, are included with those of Microsoft as of March 31, 2000.
Operating results for Visio from prior periods were not material to the combined
results of the two companies. Accordingly, the financial statements for such
periods have not been restated.
In November 1999, Expedia, Inc. completed an initial public offering of its
common stock. Expedia, which is majority-owned by Microsoft, is a leading
provider of branded online travel services for leisure and small business
travelers. Expedia's financial results and financial condition are consolidated
with the operations of Microsoft.
In September 1999, the Company sold the entertainment city guide portion of
MSN(TM) Sidewalk(R) to Ticketmaster Online-CitySearch, Inc. (TMCS) for a
combination of TMCS stock and warrants with a value of $223 million. The
transaction also included a distribution agreement. Microsoft recognized a gain
of $156 million on the sale and will recognize amounts related to the
distribution arrangement over the term of the agreement.
In November 1998, Microsoft acquired LinkExchange, Inc., a leading provider of
online marketing services to web site owners and small and medium-sized
businesses. Microsoft paid $265 million in stock. The Company did not record an
in-process technology write-off in connection with the purchase of LinkExchange.
In August 1998, the Company sold a wholly-owned subsidiary, Softimage, Inc. to
Avid Technology, Inc. Microsoft received cash of $79 million and securities
valued at $85 million. A pretax gain of $160 million was recognized in the first
quarter of fiscal 1999.
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6
<PAGE>
Contingencies
On October 7, 1997, Sun Microsystems, Inc. ("Sun") brought suit against
Microsoft in the U.S. District Court for the Northern District of California.
Sun's complaint alleges several claims against Microsoft, all related to the
parties' relationship under a March 11, 1996 Technology License and Distribution
Agreement (Agreement) concerning certain Java programming language technology.
On March 24, 1998, the Court entered an order enjoining Microsoft from using the
Java Compatibility logo on Internet Explorer 4.0 and the Microsoft Software
Developers Kit (SDK) for Java 2.0. Microsoft has taken steps to fully comply
with the order.
On November 17, 1998, the Court entered an order granting Sun's request for a
preliminary injunction, holding that Sun had established a likelihood of success
on its copyright infringement claims, because Microsoft's use of Sun's
technology in its products was beyond the scope of the parties' license
agreement. The Court ordered Microsoft to make certain changes in its products
that include Sun's Java technology and to make certain changes in its Java
software development tools. The Court also enjoined Microsoft from entering into
any licensing agreements that were conditioned on exclusive use of Microsoft's
Java Virtual Machine. Microsoft appealed that ruling to the 9th Circuit Court of
Appeals on December 16, 1998. Microsoft filed a motion on February 5, 1999,
seeking clarification of the Court's order that Microsoft would not be prevented
from engaging in independent development of Java technology under the order. The
Court granted that motion. On July 23, 1999 the Court also granted Microsoft's
motion to increase the bond on the preliminary injunction from $15 million to
$35 million.
On August 23,1999 the 9th Circuit Court of Appeals vacated the November 1998
preliminary injunction and remanded the case to the district Court for further
proceedings. Sun immediately filed two motions to reinstate and expand the scope
of the earlier injunction on the basis of copyright infringement and unfair
competition. On January 25, 2000, the Court issued rulings on the two motions,
denying Sun's motion to reinstate the preliminary injunction on the basis of
copyright infringement and granting, in part, Sun's motion to reinstate the
preliminary injunction based on unfair competition. Microsoft is in compliance
with the terms of the partially reinstated preliminary injunction and will not
need to undertake any further action to comply with the terms of the injunction.
No other hearing or trial dates have been set.
The parties have filed multiple summary judgment motions on the interpretation
of the Agreement and on Sun's copyright and trademark infringement claims. On
February 25, 2000, the court entered an order denying both parties' motions for
summary judgment as to whether the Agreement authorizes Microsoft to distribute
independently developed Java Technology. On April 5, 2000, the trial court
entered an order denying Sun's motion for summary judgment regarding the
interpretation of Section 2.7(a), which sets forth certain requirements that Sun
must meet when they deliver Java Technology to Microsoft. On May 9, 2000, the
court entered an order granting Microsoft's motion to dismiss Sun's copyright
infringement claim.
On May 18, 1998, the Antitrust Division of the U.S. Department of Justice (DOJ)
and a group of 20 state Attorneys General filed two antitrust cases against
Microsoft in the U.S. District Court for the District of Columbia. The DOJ
complaint alleges violations of Sections 1 and 2 of the Sherman Act. The DOJ
complaint seeks declaratory relief as to the violations it asserts and
preliminary and permanent injunctive relief regarding: the inclusion of Internet
browsing software (or other software products) as part of Windows; the terms of
agreements regarding non-Microsoft Internet browsing software (or other software
products); taking or threatening "action adverse" in consequence of a person's
failure to license or distribute Microsoft Internet browsing software (or other
software product) or distributing competing products or cooperating with the
government; and restrictions on the screens, boot-up sequence, or functions of
Microsoft's operating system products. The state Attorneys General allege
largely the same claims and various pendent state claims. The states seek
declaratory relief and preliminary and permanent injunctive relief similar to
that sought by the DOJ, together with statutory penalties under the state law
claims. The foregoing description is qualified in its entirety by reference to
the full text of the complaints and other papers on file in those actions, case
numbers 98-1232 and 98-1233.
On May 22, 1998, Judge Jackson consolidated the two actions. The judge granted
Microsoft's motion for summary judgment as to the states' monopoly leverage
claim and permitted the remaining claims to proceed to trial. Trial began on
October 19, 1998 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
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7
<PAGE>
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. The plaintiffs' proposal also seeks
imposition of extensive conduct remedies, applicable for three years after a
break-up is completed, or for ten years if Microsoft is not broken up.
Microsoft's initial response to this proposal, its proposed remedy, and its
proposal for the process the court should adopt in the remedies phase was filed
on May 10, 2000. Microsoft also filed a motion asking the court to summarily
dismiss break-up as a remedy. Microsoft proposed several schedules for remedy
proceedings, depending upon the scope of remedies the court was prepared to
consider. The proposed schedules range from entering immediately Microsoft's
proposed remedy (conduct restrictions addressing the conduct the court found to
violate the law) to a hearing beginning in December, 2000 if the court is going
to consider all the remedies sought by the plaintiffs. The plaintiffs will reply
on May 17 and the Court will hold a hearing on May 24, 2000. Microsoft intends
to appeal from the final judgment when entered. In other ongoing investigations,
the DOJ and several state Attorneys General have requested information from
Microsoft concerning various issues.
A number of antitrust class action lawsuits have been initiated against
Microsoft. Microsoft believes the claims are without merit and will vigorously
defend the cases.
The Securities and Exchange Commission is conducting a non-public investigation
into the Company's accounting reserve practices. Microsoft is also subject to
various legal proceedings and claims that arise in the ordinary course of
business.
Management currently believes that resolving these matters will not have a
material adverse impact on the Company's financial position or its results of
operations.
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8
<PAGE>
Segment Information
(In millions)
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<TABLE>
<CAPTION>
Productivity
Windows Applications Consumer Reconciling
Three Months Ended Mar. 31 Platforms and Developer and Other Amounts Consolidated
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1999
Revenue $2,119 $2,330 $ 421 $(275) $ 4,595
Operating income (loss) 1,349 1,434 (363) (191) 2,229
- ------------------------------------------------------------------------------------------------------------
2000
Revenue $2,327 $2,479 $ 682 $ 168 $ 5,656
Operating income (loss) 1,430 1,127 (316) 487 2,728
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<CAPTION>
Productivity
Windows Applications Consumer Reconciling
Nine Months Ended Mar. 31 Platforms and Developer and Other Amounts Consolidated
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1999
Revenue $6,443 $6,416 $1,450 $(326) $13,983
Operating income (loss) 4,275 3,921 (776) (395) 7,025
- ------------------------------------------------------------------------------------------------------------
2000
Revenue $6,947 $7,532 $2,054 $ 619 $17,152
Operating income (loss) 4,475 3,909 (677) 706 8,413
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</TABLE>
The Company's organizational structure and fundamental approach to business
reflect the needs of its customers. As such, Microsoft has three major segments:
Windows Platforms; Productivity Applications and Developer; and Consumer and
Other. Windows Platforms includes the Windows Division, which is primarily
responsible for developing and marketing Windows NT, Windows 2000, Windows 98,
and Windows 95. Productivity Applications and Developer includes the Business
Productivity Division, which is responsible for developing and marketing desktop
applications, server applications, and developer tools. Consumer and Other
products and services include primarily learning, entertainment, and PC input
device products; WebTV and PC online access; and portal and vertical properties.
Assets of the segment groups are not relevant for management of the businesses
nor for disclosure.
The Company's financial reporting systems present various data for management to
run the business, including profit and loss (P&L) statements prepared on a basis
not consistent with generally accepted accounting principles. Reconciling items
include certain elements of unearned revenue, the treatment of certain channel
inventory amounts and estimates, and revenue from product support, consulting,
and training and certification of system integrators. Additionally, the internal
P&Ls use accelerated methods of depreciation and amortization. In fiscal 2000,
the Company's internal P&Ls included the Black-Scholes value of employee stock
option grants, amortized over the remaining months of the fiscal year of the
grant. Prior year disclosures have been restated for consistent presentation.
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9
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
Microsoft develops, manufactures, licenses, and supports a wide range of
software products for a multitude of computing devices. Microsoft software
includes scalable operating systems for intelligent devices, personal computers
(PCs), and servers; server applications for client/server environments;
knowledge worker productivity applications; and software development tools. The
Company's online efforts include the MSN network of Internet products and
services and alliances with companies involved with broadband access and various
forms of digital interactivity. Microsoft also licenses consumer software
programs; sells PC input devices; trains and certifies system integrators; and
researches and develops advanced technologies for future software products.
Revenue
Revenue of $5.66 billion in the March quarter of fiscal 2000 increased 23% over
the third quarter of fiscal 1999. The revenue growth was driven by demand for
Microsoft(R) Windows(R) 2000 Professional in the retail channel following
worldwide availability during the quarter, and licensing of Microsoft Office
2000. Partially offsetting this was slower growth from Windows operating systems
sold through the original equipment manufacturer (OEM) channel due to slow
demand for business PCs. As described more fully below, reported revenue in the
third quarter of fiscal 1999 included adjustments related to the Microsoft
Office 2000 Technology Guarantee and the fulfillment of free upgrades to
Microsoft SQL Server(TM) 7.0. On a year to date basis, revenue in the first nine
months of fiscal 2000 totaled $17.15 billion, an increase of 23% over the first
nine months of fiscal 1999.
Software license volume increases have been the principal factor in the
Company's revenue growth. The average selling price per license has decreased,
primarily because of general shifts in the sales mix from retail packaged
products to licensing programs, from new products to product upgrades, and from
stand-alone desktop applications to integrated product suites. Average revenue
per license from original equipment manufacturer (OEM) licenses and
organizational license programs is lower than average revenue per license from
retail versions. Likewise, product upgrades have lower prices than new products.
Also, prices of integrated suites, such as Microsoft Office and BackOffice, are
less than the sum of the prices for the individual programs included in these
suites when such programs are licensed separately. An increased percentage of
products and programs included elements that were billed but unearned and
recognized ratably, such as Microsoft Windows, Microsoft Office, maintenance,
and other subscription models. See accompanying notes to financial statements.
Business Divisions
Microsoft has three major segments: Productivity Applications and Developer;
Windows Platforms; and Consumer and Other.
Productivity Applications and Developer products include desktop applications
such as Microsoft Office, server applications such as Microsoft Exchange Server
and Microsoft SQL Server, and software developer tools. Reported revenue
increased 32% to $2.59 billion in the March quarter. For the first three
quarters of fiscal 2000, revenue of $7.83 billion grew 33% over the first three
quarters of fiscal 1999. Revenue growth from Microsoft Office integrated suites,
including the Premium, Professional, Small Business, and Standard Editions was
healthy. Reported revenue from Microsoft Office integrated suites in the third
quarter of fiscal 1999 excluded $400 million of revenue that was not earned
related to the Microsoft Office 2000 Technology Guarantee, of which $64 million
was recognized in the second quarter of fiscal 2000 and $150 million was
recognized in the first quarter of fiscal 2000 due to fulfillment of the
guarantee during the fourth quarter of fiscal 1999 and the first two quarters of
fiscal 2000. Revenue from server applications remained solid during the third
quarter of fiscal 2000, compared to the third quarter in the prior year, which
included $45 million of earned revenue due to the fulfillment of free upgrades
to SQL Server 7.0. Software developer tools revenue declined, due to a larger
portion of licenses sold through a subscription-based model.
Windows Platforms products include primarily Windows 98, Windows 2000
Professional, Windows 2000 Server, Windows NT Workstation, and Windows NT
Server. Revenue of $2.31 billion in the third quarter represented growth of 14%
over the prior year. Windows-based desktop operating systems revenue grew
moderately. Revenue growth from Windows-based units licensed through the PC
original equipment manufacturer (OEM) channel reflected soft demand for business
PCs and a decrease in average earned revenue per licensed operating system.
Windows operating systems sold through retail channels reflected stronger than
expected demand for the newest version of the desktop operating system, Windows
2000 Professional. Windows Platform Server revenue growth was strong. On a year
to date basis, Windows Platforms revenue of $7.01 billion grew 12% over the
prior year. Second quarter OEM revenue reflected slower growth of corporate PC
purchases, moderate consumer PC purchases
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10
<PAGE>
through traditional retail channels, and declining revenue from retail versions
of Windows 98. Windows NT Workstation and Windows NT Server revenue growth in
the second quarter slowed due to customer anticipation of the next version of
the operating system, Windows 2000. First quarter OEM revenue of Windows was
relatively strong, particularly for Windows NT Workstation. Revenue from retail
packaged product versions of Windows 98 decreased in the first quarter,
reflecting the strong comparable quarter of the prior year which included
significant revenue from Windows 98 after its launch in June 1998. Windows NT
Server revenue growth was robust during the first quarter.
Consumer and Other products include Internet access and online services;
learning and entertainment software; PC input devices; consulting; and training
and certification. Revenue in the March quarter was $756 million, up 26% from
the comparable quarter of fiscal 1999. Online revenue growth was very healthy,
but was offset somewhat by the company's lower net prices for Internet access
subscriptions compared to the prior year. Hardware product revenue, reflecting
strong sales of the Company's new keyboard and PC input device offerings, was
robust. Learning and entertainment software revenue grew moderately in the third
quarter of fiscal 2000. Consumer and Other revenue of $2.31 billion grew 26%
over the first nine months of the prior year. Learning and entertainment
software posted superb growth in the second quarter of fiscal 2000, reflecting
strong consumer Holiday demand.
Distribution Channels
Microsoft distributes its products primarily through OEM licenses,
organizational licenses, and retail packaged products. OEM channel revenue
represents license fees from original equipment manufacturers who pre-install
Microsoft products, primarily on PCs. Microsoft has three major geographic sales
and marketing organizations: the South Pacific and Americas Region; the Europe,
Middle East, and Africa Region; and the Asia Region. Sales of organizational
licenses and packaged products via these channels are primarily to and through
distributors and resellers.
OEM third quarter revenue of $1.67 billion represented an increase of 5% over
the comparable quarter of fiscal 1999. The relatively low growth rate was due to
soft demand for business PCs. Average earned revenue per license also declined,
due in part to a mix shift to the lower-priced Windows operating system
reflecting the softness in demand for business PCs and lower prices of certain
operating systems licensed through the OEM channel, compared to the third
quarter of fiscal 1999. Revenue from Windows 2000 Professional in the OEM
channel was modest due to mid-quarter availability of the new operating system,
coupled with slow PC shipments to corporations, the primary end-users of Windows
2000. OEM revenue of $5.28 billion in the first three quarters of fiscal 2000
increased 11% over the first three quarters of fiscal 1999. OEM revenue in the
second quarter of fiscal 2000 grew 4% over the comparable quarter of fiscal
1999, due to slow growth in business PCs, lower average revenue per license, and
slower demand for Windows NT Workstation in anticipation of the launch of
Windows 2000 Professional. The OEM revenue grew 27% in the first quarter of
fiscal 2000, reflecting strong PC growth and increased penetration of higher-
value NT Workstation.
South Pacific and Americas Region revenue in the March quarter increased 32% to
$2.02 billion. Revenue for the first nine months of fiscal 2000 grew 25% over
the first nine months of fiscal 1999 to $6.09 billion. Windows 2000 retail sales
and Office integrated suites were the primary drivers of the revenue growth.
Organizational licensing activity of server applications was moderate. Revenue
growth was particularly strong in Latin America and Australia, moderate in the
United States, and modest in Canada.
Europe, Middle East, and Africa Region third quarter revenue of $1.26 billion
was up 28% compared to the third quarter of fiscal 1999. Retail sales of Windows
2000 operating systems and Office licensing produced strong growth in the
region. Hardware devices and learning and productivity software exhibited strong
results. Revenue growth, measured in constant dollars, was low in the United
Kingdom and France, moderate in Germany, and strong in the Middle East.
Weakening local currencies negatively impacted translated revenue compared to
the prior year quarter. Revenue in the region would have grown 37% if foreign
exchange rates were constant with those of the year ago quarter. For the first
three quarters of fiscal 2000, revenue in the region totaled $3.87 billion, an
increase of 24% over the prior year.
Asia Region revenue in the third quarter increased 44% to $709 million from the
third quarter of the prior year, reflecting improved local economic conditions
and strong revenue from localized versions of Windows 2000 and Office integrated
suites, particularly in Japan. Revenue grew strongly in most countries in the
Asia region. Strengthening local currencies positively impacted translated
revenue compared to the prior year. Revenue in the region would have grown 32%
if foreign exchange rates were constant with those of the year ago quarter. On a
year to date basis, revenue in the Asia region was $1.91 billion, up 58% from
the comparable period.
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11
<PAGE>
Translated international revenue is affected by foreign exchange rates. The net
impact of foreign exchange rates on revenue was negative in the March quarter
compared to a year ago, due to weaker European currencies versus the U.S.
dollar, offset partially by stronger Japanese yen versus the U.S. dollar. Had
the rates from the prior year been in effect in the third quarter of fiscal
2000, translated international revenue billed in local currencies would have
been $25 million higher. In the first half of fiscal 2000, the strong Japanese
yen more than offset weak European currencies and added $64 million in the first
quarter and $35 million in the second quarter to translated revenue. Certain
manufacturing, selling, distribution, and support costs are disbursed in local
currencies, and a portion of international revenue is hedged, thus offsetting a
portion of the translation exposure.
Operating Expenses
Microsoft encourages broad-based employee ownership of Microsoft stock through
an employee stock option (ESO) program in which most employees are eligible to
participate. Microsoft follows Accounting Principals Board Opinion 25 (APB 25)
to account for ESOs, which generally does not require income statement
recognition of options granted at the market price on the date of issuance, and
discloses the Black-Scholes value of option grants. Payroll taxes associated
with stock option exercises are recorded as an expense. Other events can also
trigger recording expense, such as using the lowest price in the 30 days
following an employee's start date to establish the strike price, accelerating
the vesting of options, and converting ESOs from one company to another, as
occurred with the initial public offering of Expedia, a majority-owned
subsidiary of Microsoft. These costs were reflected in each operating expense
line item in the income statement in the March quarter of fiscal 2000 and
totaled $90 million. These costs totaled $170 million in the second quarter and
$100 million in the first quarter of fiscal 2000.
Cost of revenue as a percent of revenue was 13.3% in the third quarter, down
from 15.4% in the third quarter of the prior year. The percentage decrease in
the third quarter of fiscal 2000 was impacted by the unearned revenue related to
the Office 2000 Technology Guarantee in the year ago quarter. For the first nine
months of fiscal 2000, the percentage was 12.9%, down from 15.3% for the first
nine months of fiscal 1999. The percentage decrease resulted primarily from the
trend in mix shift to organizational licenses and lower costs associated with
WebTV(R) Networks' operations.
Research and development expenses increased 49% from the third quarter of the
prior year to $990 million. For the first three quarters of fiscal 2000,
research and development expenses increased 35% to $2.74 billion from the first
three quarters of fiscal 1999. These increases were driven primarily by higher
development headcount-related costs, including various charges related to
employee stock options, and investments in new product initiatives.
Sales and marketing expenses were $1.04 billion in the March quarter, or 18.4%
of revenue, compared to 18.5% in the third quarter of the prior year. Sales and
marketing expenses as a percent of revenue decreased slightly due to lower
relative sales expenses, partially offset by higher relative marketing costs. On
a year to date basis, sales and marketing expenses were $2.97 billion, up 27%
over the comparable period of the prior year, due primarily to both higher
relative marketing costs and certain employee stock option expenses.
General and administrative costs were $176 million in the third quarter compared
to $144 million in the prior year. For the first three quarters of fiscal 2000,
general and administrative costs were $825 million, compared to $392 million in
the first three quarters of fiscal 1999. The second quarter of fiscal 2000
included a charge for the settlement of the lawsuit with Caldera, Inc. General
and administrative costs also included increased legal fees and certain stock
option-related charges.
Other expenses and income include miscellaneous items, including certain gains
and the recognition of Microsoft's share of joint venture activities, including
Transpoint, WebTV Networks K.K., and the MSNBC entities.
Investment Income, Gains on Sales, and Income Taxes
Third quarter investment income increased to $885 million from $720 million in
the third quarter of the prior year. Year to date investment income totaled
$2.06 billion in fiscal 2000, compared to $1.32 billion in fiscal 1999. The
increase was due principally to realized gains of approximately $440 million in
the third quarter, $400 million in the second quarter and $50 million in the
first quarter. The larger investment portfolio generated by cash from operations
also contributed to the increase in investment income. Realized gains in the
third quarter of fiscal 1999 were approximately $350 million.
During the first quarter of fiscal 2000, Microsoft sold the entertainment city
guide portion of MSN(TM) Sidewalk(R) to Ticketmaster Online-CitySearch, Inc.
(TMCS) for a combination of TMCS stock and warrants. Microsoft recognized a gain
of $156 million.
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<PAGE>
During the first quarter of fiscal 1999, Microsoft sold its Softimage, Inc.
subsidiary to Avid Technology, Inc for a pretax gain of $160 million.
The effective tax rate for the first nine months of fiscal 2000 was 34%.
Excluding the tax impact of the gain on the sale of Softimage, the effective tax
rate for fiscal 1999 was 35%.
Financial Condition
The Company's cash and short-term investment portfolio totaled $21.21 billion at
March 31, 2000. The portfolio is diversified among security types, industries,
and individual issuers. Microsoft's investments are generally liquid and
investment grade. The portfolio is invested predominantly in U.S. dollar
denominated securities, but also includes foreign currency positions in
anticipation of continued international expansion. The portfolio is primarily
invested in short-term securities to minimize interest rate risk and facilitate
rapid deployment in the event of immediate cash needs.
Microsoft also invests in equities, primarily strategic technology companies.
The Company has made large-scale investments in access providers, including
cable, telephony, and wireless communications companies. During the first
quarter of fiscal 2000, the Company purchased $400 million of Rogers
Communications convertible preferred securities and warrants. In connection with
AT&T's proposed merger with MediaOne Group, Inc., the Company agreed to acquire
MediaOne's interest in Telewest Communications plc, a leading provider of cable
television and residential and business cable telephony services in the United
Kingdom, subject to certain regulatory approvals and other conditions.
Microsoft and National Broadcasting Company (NBC) operate two MSNBC joint
ventures: a 24-hour cable news and information channel, and an online news
service. Microsoft is paying $220 million over a five-year period that ends in
2001 for its interest in the cable venture and one-half of the operational
funding of both joint ventures. Microsoft guarantees a portion of MSNBC debt.
Microsoft has no material long-term debt and has $163 million of standby
multicurrency lines of credit to support foreign currency hedging and cash
management. Stockholders' equity at March 31, 2000 was $39.79 billion.
Microsoft will continue to invest in sales, marketing, and product support
infrastructure. Additionally, research and development activities will include
investments in existing and advanced areas of technology, including using cash
to acquire technology. Cash will also be used to fund ventures and strategic
opportunities. Additions to property and equipment will continue, including new
facilities and computer systems for R&D, sales and marketing, support, and
administrative staff. Commitments for constructing new buildings were $377
million on March 31, 2000.
Since fiscal 1990, Microsoft repurchased 764 million common shares while 1.95
billion shares were issued under the Company's employee stock option and
purchase plans. Microsoft enhanced its repurchase program by selling put
warrants. In January 2000, the Company announced the termination of its stock
buyback program. The market value of all outstanding stock options was $80
billion as of March 31, 2000. During December 1996, Microsoft issued 12.5
million shares of 2.75% convertible exchangeable preferred stock. Net proceeds
of $980 million were used to repurchase common shares. The Company's convertible
preferred stock matured on December 15, 1999. Each preferred share was converted
into 1.1273 common shares.
Management believes existing cash and short-term investments together with funds
generated from operations will be sufficient to meet operating requirements for
the next 12 months. The Company's cash and short-term investments are available
for strategic investments, mergers and acquisitions, and other potential large-
scale cash needs that may arise.
Microsoft has not paid cash dividends on its common stock.
- --------------------------------------------------------------------------------
13
<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
The Company filed no reports on Form 8-K during the quarter ended March 31,
2000.
Items 2, 3, 4, and 5 are not applicable and have been omitted.
- --------------------------------------------------------------------------------
14
<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 12, 2000 By: /s/ John G. Connors
---------------------
John G. Connors
Senior Vice President, Finance and
Administration;
Chief Financial Officer
(Principal Financial and Accounting Officer
and Duly Authorized Officer)
- --------------------------------------------------------------------------------
15
<TABLE> <S> <C>
<PAGE>
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<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
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TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 9-MOS
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<PERIOD-START> JUL-01-1999
<PERIOD-END> MAR-31-2000
<CASH> 21,205
<SECURITIES> 0
<RECEIVABLES> 2,902
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<PP&E> 4,128
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