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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 September 30, 2001
[_] 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
September 30, 2001 was 5,385,753,545.
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MICROSOFT CORPORATION
FORM 10-Q
For the Quarter Ended September 30, 2001
INDEX
Part I. Financial Information
Item 1. Financial Statements Page
----
a) Income Statements
for the Three Months Ended September 30, 2000 and 2001 ......... 1
b) Balance Sheets
as of June 30, 2001 and September 30, 2001 ..................... 2
c) Cash Flows Statements
for the Three Months Ended September 30, 2000 and 2001 ......... 3
d) Stockholders' Equity Statements
for the Three Months Ended September 30, 2000 and 2001 ......... 4
e) Notes to Financial Statements .................................. 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ................................ 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk ......... 14
Part II. Other Information
Item 1. Legal Proceedings .................................................. 15
Item 6. Exhibits and Reports on Form 8-K ................................... 15
Signature ............................................................................ 16
Part I. Financial Information
Item 1. Financial Statements
MICROSOFT CORPORATION
Income Statements
(In millions, except earnings per share)(Unaudited)
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Three Months Ended
Sept. 30
2000 2001
----------------------------------------------------------------------------------
Revenue $5,766 $6,126
Operating expenses:
Cost of revenue 825 884
Research and development 956 1,013
Sales and marketing 1,038 1,145
General and administrative 170 187
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Total operating expenses 2,989 3,229
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Operating income 2,777 2,897
Losses on equity investees and other (52) (30)
Investment income/(loss) 1,127 (980)
----------------------------------------------------------------------------------
Income before income taxes 3,852 1,887
Provision for income taxes 1,271 604
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Income before accounting change 2,581 1,283
Cumulative effect of accounting change (net of
income taxes of $185) (375) -
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Net income $2,206 $1,283
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Basic earnings per share:
Before accounting change $ 0.49 $ 0.24
Cumulative effect of accounting change (0.07) -
----------------------------------------------------------------------------------
$ 0.42 $ 0.24
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Diluted earnings per share:
Before accounting change $ 0.46 $ 0.23
Cumulative effect of accounting change (0.06) -
----------------------------------------------------------------------------------
$ 0.40 $ 0.23
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Weighted average shares outstanding:
Basic 5,299 5,398
----------------------------------------------------------------------------------
Diluted 5,557 5,567
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See accompanying notes.
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1
MICROSOFT CORPORATION
Balance Sheets
(In millions)
--------------------------------------------------------------------------------
June 30 Sept. 30
2001 2001 (1)
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Assets
Current assets:
Cash and equivalents $ 3,922 $ 3,113
Short-term investments 27,678 33,050
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Total cash and short-term investments 31,600 36,163
Accounts receivable 3,671 3,615
Deferred income taxes 1,949 1,993
Other 2,417 2,561
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Total current assets 39,637 44,332
Property and equipment, net 2,309 2,261
Equity investments 14,361 12,035
Goodwill 1,511 1,511
Intangible assets, net 401 394
Other assets 1,038 834
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Total assets $59,257 $61,367
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Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 1,188 $ 1,143
Accrued compensation 742 586
Income taxes 1,468 2,131
Unearned revenue 5,614 5,849
Other 2,120 3,153
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Total current liabilities 11,132 12,862
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Deferred income taxes 836 -
---------------------------------------------------------------------------------------------------------
Commitments and contingencies
Stockholders' equity:
Common stock and paid-in capital -
shares authorized 12,000; outstanding 5,383 and 5,386 28,390 29,296
Retained earnings, including accumulated other comprehensive
income of $587 and $621 18,899 19,209
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Total stockholders' equity 47,289 48,505
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Total liabilities and stockholders' equity $59,257 $61,367
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(1) Unaudited
See accompanying notes.
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2
MICROSOFT CORPORATION
Cash Flows Statements
(In millions)(Unaudited)
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Three Months Ended
Sept. 30
2000 2001
---------------------------------------------------------------------------------------------------------
Operations
Net income $ 2,206 $ 1,283
Cumulative effect of accounting change, net of tax 375 -
Depreciation, amortization, and other noncash items 250 282
Net recognized (gains)/ losses on investments (599) 1,517
Stock option income tax benefits 453 415
Deferred income taxes 734 (839)
Unearned revenue 1,457 1,104
Recognition of unearned revenue from prior periods (1,507) (914)
Accounts receivable 116 69
Other current assets (211) (39)
Other long-term assets (61) 122
Other current liabilities (253) 389
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Net cash from operations 2,960 3,389
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Financing
Common stock issued 375 391
Common stock repurchased (1,752) (1,125)
Put warrant proceeds 81 -
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Net cash used for financing (1,296) (734)
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Investing
Additions to property and equipment (245) (150)
Purchases of investments (13,723) (16,020)
Maturities of investments 1,570 861
Sales of investments 8,462 11,840
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Net cash used for investing (3,936) (3,469)
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Net change in cash and equivalents (2,272) (814)
Effect of exchange rates on cash and equivalents 67 5
Cash and equivalents, beginning of period 4,846 3,922
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Cash and equivalents, end of period $ 2,641 $ 3,113
=========================================================================================================
See accompanying notes.
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3
MICROSOFT CORPORATION
Stockholders' Equity Statements
(In millions)(Unaudited)
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Three Months Ended
Sept. 30
2000 2001
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Common stock and paid-in capital
Balance, beginning of period $23,195 $28,390
Common stock issued 3,055 609
Common stock repurchased (123) (118)
Proceeds from sale of put warrants 81 -
Stock option income tax benefits 453 415
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Balance, end of period 26,661 29,296
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Retained earnings
Balance, beginning of period 18,173 18,899
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Net income 2,206 1,283
Other comprehensive income:
Cumulative effect of accounting change (75) -
Net gains/(losses) on derivative instruments 432 (51)
Net unrealized investment gains/(losses) (484) 46
Translation adjustments and other 59 39
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Comprehensive income 2,138 1,317
Common stock repurchased (1,629) (1,007)
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Balance, end of period 18,682 19,209
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Total stockholders' equity $45,343 $48,505
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See accompanying notes.
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4
MICROSOFT CORPORATION
Notes To Financial Statements
(Unaudited)
--------------------------------------------------------------------------------
Basis of Presentation
In the opinion of management, the accompanying balance sheets and related
interim statements of income, cash flows, and stockholders' equity include all
adjustments, consisting only of normal recurring items, as well as the
accounting changes to adopt Statement of Financial Accounting Standards (SFAS)
133, Accounting for Derivative Instruments and Hedging Activities, SFAS 141,
Business Combinations, and SFAS 142, Goodwill and Other Intangible Assets,
necessary for their fair presentation in conformity with U.S. generally accepted
accounting principles. Preparing financial statements requires management to
make estimates and assumptions that affect the reported amounts of assets,
liabilities, revenue, and expenses. Examples include provisions for returns,
concessions and bad debts, and the length of product life cycles and buildings'
lives. Actual results may differ from these estimates. Interim results are not
necessarily indicative of results for a full year. The information included in
this Form 10-Q should be read in conjunction with Management's Discussion and
Analysis and financial statements and notes thereto included in the Microsoft
Corporation 2001 Form 10-K. Certain reclassifications have been made for
consistent presentation.
Accounting Changes
Effective July 1, 2000, Microsoft adopted SFAS 133, which establishes accounting
and reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. The adoption
of SFAS 133 resulted in a pre-tax reduction to income of $560 million ($375
million after-tax) and a pre-tax reduction to other comprehensive income (OCI)
of $112 million ($75 million after-tax).
Effective July 1, 2001, Microsoft adopted SFAS 141 and SFAS 142. SFAS 141
requires business combinations initiated after June 30, 2001 to be accounted for
using the purchase method of accounting. It also specifies the types of acquired
intangible assets that are required to be recognized and reported separate from
goodwill. SFAS 142 requires that goodwill and certain intangibles no longer be
amortized, but instead tested for impairment at least annually. There was no
impairment of goodwill upon adoption of SFAS 142.
Net income and earnings per share for the first quarter of fiscal 2001 adjusted
to exclude amortization expense (net of taxes) is as follows:
Three Months
Ended
Sept. 30,
(In millions, except earnings per share) 2000
--------------------------------------------------------
Net income:
Reported net income $2,206
Goodwill amortization 56
Equity method goodwill amortization 5
--------------------------------------------------------
Adjusted net income $2,267
========================================================
Basic earnings per share:
Reported basic earnings per share $0.42
Goodwill amortization 0.01
Equity method goodwill amortization -
--------------------------------------------------------
Adjusted basic earnings per share $0.43
========================================================
Diluted earnings per share:
Reported diluted earnings per share $0.40
Goodwill amortization 0.01
Equity method goodwill amortization -
--------------------------------------------------------
Adjusted diluted earnings per share $0.41
========================================================
During the first quarter of fiscal 2002, no goodwill was acquired, impaired, or
written off. As of September 30, 2001, Desktop and Enterprise Software and
Services goodwill was $1.10 billion, Consumer Software, Services, and Devices
goodwill was $256 million, and Consumer Commerce Investments goodwill was $151
million.
All of Microsoft's acquired intangible assets are subject to amortization.
During the first quarter of fiscal 2002, the Company acquired $35 million in
contract-based intangible assets and $13 million in technology-based intangible
assets, which will be amortized over approximately 3 years. No
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5
significant residual value is estimated for these intangible assets.
Intangible assets amortization expense for the first quarter of fiscal 2002 was
$55 million. The components of intangible assets were as follows:
June 30, 2001 Sept. 30, 2001
-------------------------------------- --------------------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
(In millions) Amount Amortization Amount Amortization
----------------------------------------------------------------------------------------------------------
Contract-based $407 $(177) $442 $(215)
Technology-based 157 (27) 170 (38)
Marketing-related and other 83 (42) 83 (48)
----------------------------------------------------------------------------------------------------------
Intangible assets $647 $(246) $695 $(301)
==========================================================================================================
Intangible assets amortization expense is estimated to be $142 million for the
remainder of fiscal 2002, $125 million in fiscal 2003, $87 million in fiscal
2004, $38 million in fiscal 2005, and $2 million in fiscal 2006.
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 put warrants using the "reverse treasury stock" method 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)
--------------------------------------------------------------------------------
Three Months Ended
Sept. 30
2000 2001
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Income before accounting change (A) $2,581 $1,283
Cumulative effect of accounting change (375) -
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Net income available for common shareholders $2,206 $1,283
=================================================================================================
Weighted average outstanding shares of common stock (B) 5,299 5,398
Dilutive effect of:
Put warrants 10 -
Employee stock options 248 169
-------------------------------------------------------------------------------------------------
Common stock and common stock equivalents (C) 5,557 5,567
=================================================================================================
Earnings per share before accounting change:
Basic (A/B) $ 0.49 $ 0.24
-------------------------------------------------------------------------------------------------
Diluted (A/C) $ 0.46 $ 0.23
=================================================================================================
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 September 30, 2001, unearned revenue was $5.85 billion,
compared to $4.77 billion at September 30, 2000. Desktop Applications unearned
revenue was $2.39 billion, compared to $1.68 billion at September 30, 2000.
Desktop Platforms unearned revenue was $2.66 billion, compared to $2.36 billion
at September 30, 2000.
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6
Enterprise Software and Services unearned revenue was $470 million, compared to
$400 million at September 30, 2000. Unearned revenue associated with Consumer
Software, Services, and Devices and Other was $325 million, compared to $328
million a year ago.
Stockholders' Equity
The Company repurchases its common shares in the open market to provide shares
for issuance to employees under stock option and stock purchase plans. During
the first quarter of fiscal 2001 and 2002, the Company repurchased 25.5 million
and 21.6 million shares of Microsoft common stock.
Operational Transactions
On July 16, 2001, USA Networks, Inc. (USA) announced an agreement to acquire a
controlling interest in Expedia, Inc. through the purchase of up to 37.5 million
shares, approximately 75% of the current outstanding shares. If holders of more
than 37.5 million Expedia shares elect to sell their shares to USA, there will
be a pro rata reduction among all of those electing shareholders. Microsoft has
agreed to transfer all of its 33.7 million shares and warrants, subject to
pro-ration. It is expected that the transaction will close by December 31, 2001.
Investment Income/(Loss)
The components of investment income/(loss) are as follows:
Three Months Ended
Sept. 30
(In millions) 2000 2001
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Dividends $ 97 $ 88
Interest 431 449
Recognized net gains/(losses) on investments 599 (1,517)
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Investment income/(loss) $1,127 $ (980)
==========================================================================================
Contingencies
The Company is a defendant in U.S. v. Microsoft, a lawsuit filed by the
Antitrust Division of the U.S. Department of Justice (DOJ) and a group of
eighteen state Attorneys General alleging violations of the Sherman Act and
various state antitrust laws. After the trial, the District Court entered
Findings of Fact and Conclusions of Law stating that Microsoft had violated
Sections 1 and 2 of the Sherman Act and various state antitrust laws. A Judgment
was entered on June 7, 2000 ordering, among other things, the breakup of
Microsoft into two companies. The Judgment was stayed pending an appeal. On June
28, 2001, the U.S. Court of Appeals for the District of Columbia Circuit
affirmed in part, reversed in part, and vacated the Judgment in its entirety and
remanded the case to the District Court for a new trial on one Section 1 claim
and for entry of a new judgment consistent with its ruling. In its ruling, the
Court of Appeals substantially narrowed the bases of liability found by the
District Court, but affirmed some of the District Court's conclusions that
Microsoft had violated Section 2. On September 6, 2001, the plaintiffs announced
that on remand they will not ask the Court to break Microsoft up, that they will
seek imposition of conduct remedies, and that they will not retry the one
Section 1 claim returned to the District Court by the Court of Appeals. On
August 7, 2001, Microsoft petitioned the Supreme Court for a writ of certiorari
to review the appellate court's ruling concerning its disqualification of the
District Court judge. The Supreme Court denied the petition on October 9, 2001.
Microsoft may petition the Supreme Court to review other aspects of the
appellate court's decision after final judgment is entered. On October 12, 2001,
the trial court held a status conference and entered orders requiring the
parties to engage in settlement discussions until November 2, 2001. If no
settlement is reached by that date, the parties will begin discovery leading to
an evidentiary hearing on remedies on March 11, 2002.
In other ongoing investigations, the DOJ and several state Attorneys General
have requested information from Microsoft concerning various issues. In
addition, the European Commission has instituted proceedings in which it alleges
that Microsoft has failed to disclose information that Microsoft competitors
claim they need to interoperate fully with Windows 2000 clients and servers and
has engaged in discriminatory licensing of such technology. The remedies sought,
though not fully defined, include mandatory disclosure of Microsoft Windows
operating system technology and imposition of fines. Microsoft denies the
European Commission's allegations and intends to contest the proceedings
vigorously.
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7
A large number of overcharge class action lawsuits have been initiated against
Microsoft. These cases allege that Microsoft has competed unfairly and
unlawfully monopolized alleged markets for operating systems and certain
software applications and seek to recover alleged overcharges that the
complaints contend Microsoft charged for these products. Microsoft believes the
claims are without merit and is vigorously defending the cases. To date,
Microsoft has won dismissals of all claims for damages by indirect purchasers
under Federal law and in 15 separate state court proceedings. Claims on behalf
of foreign purchasers have also been dismissed. Plaintiffs have appealed most of
these rulings. While no trials or other proceedings have been held concerning
any liability issues, courts in several states have ruled that these cases may
proceed as class actions, while one court has denied class certification status
to the claims in that state proceeding.
A purported class action employment discrimination case is pending against
Microsoft, Donaldson v. Microsoft, a single action consolidating three
separately filed class action complaints filed in October 2000 and February 2001
in Federal court in Seattle, Washington. The Donaldson plaintiffs purport to
represent a nationwide class of current and former African American and female
Microsoft employees and seek injunctive relief, an unspecified amount of
compensatory and punitive damages, and attorneys' fees. The Donaldson plaintiffs
allege that Microsoft's compensation, evaluation, and promotion policies are
discriminatory with respect to the plaintiffs in violation of Title VII of the
1964 Civil Rights Act and 42 U.S.C. (S) 1981. A class certification hearing was
held before the district court on October 19, 2001 and a decision is expected
shortly. Microsoft denies the allegations and is vigorously defending the case.
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.
Segment Information
(In millions)
--------------------------------------------------------------------------------------------------------------
Desktop and Consumer
Enterprise Software, Consumer
Three Months Software Services, Commerce Reconciling
Ended Sept. 30 and Services and Devices Investments Other Amounts Consolidated
--------------------------------------------------------------------------------------------------------------
2000
Revenue $5,119 $ 463 $ 63 $156 $ (35) $5,766
Operating income (loss) 3,385 (261) (39) 20 (328) $2,777
--------------------------------------------------------------------------------------------------------------
2001
Revenue $5,433 $ 484 $ 94 $126 $ (11) $6,126
Operating income (loss) 3,413 (318) 6 16 (220) 2,897
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Desktop and Enterprise Software and Services Revenue:
Three Months Ended
Sept. 30
(In millions) 2000 2001
----------------------------------------------------------------------------
Desktop Applications $2,075 $2,212
Desktop Platforms 1,992 2,016
----------------------------------------------------------------------------
Desktop Software 4,067 4,228
Enterprise Software and Services 1,052 1,205
----------------------------------------------------------------------------
Total Desktop and Enterprise Software
and Services $5,119 $5,433
----------------------------------------------------------------------------
Microsoft has four segments: Desktop and Enterprise Software and Services;
Consumer Software, Services, and Devices; Consumer Commerce Investments; and
Other. Desktop and Enterprise Software and Services operating
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8
segment includes Desktop Applications, Desktop Platforms, and Enterprise
Software and Services. Desktop Applications include Microsoft Office; Microsoft
Project; Visio; client access licenses for Windows NT Server and Windows 2000
Server, Exchange, and BackOffice; Microsoft Great Plains; and bCentral. Desktop
Platforms include Windows 2000 Professional, Windows NT Workstation, Windows
Millennium Edition (Windows Me), Windows 98, and other desktop operating
systems. Enterprise Software and Services includes Server Platforms; Server
Applications; developer tools and services; and Enterprise services. Consumer
Software, Services, and Devices operating segment includes MSN Internet access,
MSN network services, PC and online games, Xbox, learning and productivity
software, mobility and embedded systems. Consumer Commerce Investments operating
segment includes Expedia, Inc., the HomeAdvisor online real estate service, and
the CarPoint online automotive service. Other primarily includes Hardware and
Microsoft Press.
Segment information is presented in accordance with SFAS 131, Disclosures about
Segments of an Enterprise and Related Information. This standard is based on a
management approach, which requires segmentation based upon the Company's
internal organization and disclosure of revenue and operating income based upon
internal accounting methods. The Company's financial reporting systems present
various data for management to run the business, including internal profit and
loss statements (P&Ls) prepared on a basis not consistent with generally
accepted accounting principles. Assets are not allocated to segments for
internal reporting presentations.
Reconciling items for revenue include certain elements of unearned revenue and
the treatment of certain channel inventory amounts and estimates. In addition to
the reconciling items for revenue, reconciling items for operating income/(loss)
include general and administrative expenses ($170 million in 2000 and $187
million in 2001), certain research expenses ($39 million in 2000 and $37 million
in 2001), and other corporate level adjustments. The internal P&Ls use
accelerated methods of depreciation and amortization. Additionally, losses on
equity investees and minority interest are classified in operating income for
internal reporting presentations.
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9
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
Microsoft develops, manufactures, licenses, and supports a wide range of
software products for a multitude of computing devices. Microsoft software
includes scalable operating systems for servers, personal computers (PCs), and
intelligent devices; server applications for client/server environments;
knowledge worker productivity applications; and software development tools. The
Company's online efforts include the MSN network of Internet products and
services and alliances with companies involved with broadband access and various
forms of digital interactivity. Microsoft also licenses consumer software
programs; sells hardware devices; provides consulting services; trains and
certifies system integrators and developers; and researches and develops
advanced technologies for future software products and services.
Management's Discussion and Analysis contains statements that are
forward-looking. These statements are based on current expectations and
assumptions that are subject to risks and uncertainties. Actual results could
differ materially because of factors such as: entry into markets with vigorous
competition, market acceptance of new products and services, adoption of new
licensing programs, continued acceptance of existing products and services,
delays in product development and related product release schedules, reliance on
sole source suppliers, or shortages of key components for hardware products that
delay product delivery, any of which may cause revenues and income to fall short
of anticipated levels; the risk of obsolete inventory or product returns by
distributors, resellers and retailers; the risk of warranty and other claims on
hardware products; higher relative marketing expenses associated with new
product releases; changes in the rate of PC shipments; technological shifts;
customer demand for Microsoft's products and services; the support of third
party software developers for new or existing platforms; competitive products,
services and pricing; changes in product and service mix; product life cycles;
sale terms and conditions; the Company's ability to efficiently integrate
acquired businesses; implementation of cost structures that align with revenue
growth; the financial condition of vendors, resellers and retailers;
unavailability of insurance; uninsured losses (including the effects of the
terrorist attacks on the United States on Sept. 11, 2001); adverse results in
litigation; the effects of terrorist activity and armed conflict such as
disruptions in general economic activity and changes in Microsoft's operations
and security arrangements; general economic conditions that affect demand for
computer hardware or software; currency fluctuations; financial market
volatility affecting the value of Microsoft's investments that may result in a
reduction in carrying value and recognition of losses; and other issues
discussed in the Company's 2001 Form 10-K.
Revenue
Revenue for the first quarter of fiscal year 2002 was $6.13 billion, an increase
of 6% over the first quarter of fiscal 2001. The revenue growth was driven
primarily by the licensing of Microsoft Windows 2000 Professional and Server,
Microsoft SQL Server, and the other .NET Enterprise Servers.
Product Revenue
Microsoft has four segments: Desktop and Enterprise Software and Services;
Consumer Software, Services, and Devices; Consumer Commerce Investments; and
Other. The Management Discussion and Analysis presentation of revenue differs
from that reported under the Company's Segment Information appearing in the
Notes to Financial Statements because reconciling items are allocated to those
segments.
Desktop and Enterprise Software and Services includes Desktop Applications;
Desktop Platforms; and Enterprise Software and Services. Desktop and Enterprise
Software and Services revenue was $5.40 billion for the first quarter, an
increase of 7% from $5.06 billion recorded in the first quarter of the prior
year. Desktop Applications includes revenue from Microsoft Office; Microsoft
Project; Visio; client access licenses (CALs) for Windows NT Server and Windows
2000 Server, Exchange, and BackOffice; Microsoft Great Plains; and bCentral.
Revenue from Desktop Applications was $2.19 billion in the September quarter of
fiscal 2002, a 2% growth from $2.14 billion in the prior year. Office revenue
reflected increased enterprise licensing of the Office XP suite, offset by
declining consumer purchases, particularly in the Asia region. Revenue grew
strongly in the first quarter of fiscal 2002 from client access licenses related
to strong licensing growth of Exchange, BackOffice, and Windows NT Server and
Windows 2000 Server CALs. Microsoft Great Plains revenue also contributed to the
growth.
Desktop Platforms includes revenue from Windows 2000 Professional, Windows NT
Workstation, Windows Millennium Edition (Windows Me), Windows 98, and other
desktop operating systems. Desktop Platforms revenue was $2.02 billion in the
first quarter, representing 7% growth from the first quarter of the prior year.
Although hampered by the weakness in PC shipments, revenue from an increased mix
of Windows 2000 Professional and earned revenue from enterprise licensing
contributed to the growth from the prior year's September quarter.
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10
Revenue from Windows 98 and Windows Me declined from the first quarter of fiscal
2001. Windows XP Home and Professional Editions were released to manufacturing
during the quarter and some OEMs began offering this new version in late
September.
Enterprise Software and Services includes Server Platforms; Server Applications;
developer tools and services; and Enterprise services. September quarter revenue
was $1.19 billion, increasing 15% from $1.04 billion in the September quarter of
fiscal 2001. Server Platforms revenue growth was greater than 20% resulting from
continued adoption of Windows 2000 Server and an increased mix of Windows 2000
Advanced Server. SQL Server, Exchange Server, and other .NET Enterprise Servers
revenue rose sharply from the prior year's first quarter as a result of strong
licensing. Enterprise services revenue, representing consulting and product
support services, was up 27% compared to the prior year's comparable quarter.
Revenue from developer tools, training and certification, and other services
declined from the September quarter of fiscal 2001 with the release of the new
version of the developer tools suite approaching.
Consumer Software, Services, and Devices includes MSN Internet access, MSN
network services, PC and online games, Xbox, learning and productivity software,
mobility and embedded systems. Consumer Software, Services, and Devices revenue
reached $501 million in the first quarter of fiscal 2002, up 5% from the first
quarter of the prior year. MSN Internet access revenue grew solidly as a result
of an increased subscriber base, partially offset by a decline in the average
revenue per subscriber due to a larger mix of subscribers contracted under
rebate programs. Revenue from MSN network services continues to face difficult
economic conditions impacting the online advertising marketplace resulting in a
slower pace of revenue growth than achieved in recent quarters. Learning and
productivity software revenue and PC and online games revenue declined from the
September quarter of fiscal 2001, due to the timing of new product releases and
the softness in the overall consumer market.
Consumer Commerce Investments include Expedia, Inc., the HomeAdvisor online real
estate service, and the Carpoint online automotive service. First quarter
revenue totaled $94 million, compared to $63 million in the prior year's first
quarter. Prior year's first quarter revenue for Expedia, Inc. has been
reclassified to reflect the reporting change of merchant revenue to a net basis,
which represents the amount charged to the customer less the amount paid to the
supplier.
On July 16, 2001, USA Networks, Inc. (USA) announced an agreement to acquire a
controlling interest in Expedia, Inc. through the purchase of up to 37.5 million
shares, approximately 75% of the current outstanding shares. If holders of more
than 37.5 million Expedia shares elect to sell their shares to USA, there will
be a pro rata reduction among all of those electing shareholders. Microsoft has
agreed to transfer all of its 33.7 million shares and warrants, subject to
pro-ration. It is expected that the transaction will close by December 31, 2001.
Other primarily includes Hardware and Microsoft Press. Other revenue was $129
million in the first quarter of fiscal 2002, declining from $165 million
reported in the prior year's September quarter. Lower sales of Microsoft Press
books due to the timing of new book releases and lower revenue from hardware
peripherals as a result of weaknesses in the consumer market contributed to the
decline in revenue from the September quarter of fiscal 2001.
Distribution Channels
Microsoft distributes its products primarily through OEM licenses,
organizational licenses, online services and products, and retail packaged
products. OEM channel revenue represents license fees from original equipment
manufacturers who pre-install Microsoft products, primarily on PCs. Microsoft
has three major geographic sales and marketing regions: the South Pacific and
Americas Region; the Europe, Middle East, and Africa Region; and the Asia
Region. Sales of organizational licenses and retail packaged products via these
channels are primarily to and through distributors and resellers.
OEM first quarter revenue was $1.98 billion, up 9% from revenue of $1.82 billion
in the comparable quarter of fiscal 2001. Although total licenses reported
declined from the prior year's first quarter, revenue growth was positively
impacted by the increased mix of the higher priced Windows 2000 Professional and
Windows NT Workstation licenses, a higher average revenue per license, and the
recognition of unearned revenue, which had been deferred in prior periods when
PC growth rates were higher. Additionally, OEM revenue reflected strength in the
system builder channel.
South Pacific and Americas Region revenue in the September quarter was $2.43
billion, up 13% compared to $2.15 billion in the prior year. Revenue from the
United States was the primary driver of the region's revenue growth, as a result
of strong enterprise licensing of the Company's server and .NET Enterprise
Servers in a weak economy due to the strong value-based offerings. Other product
offerings influencing the growth included Windows NT Workstation and Windows
2000 Professional, enterprise consulting and support services, and MSN
access.
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Office integrated suites revenue showed a healthy increase from the prior year's
comparable quarter as a result of licensing of Microsoft Office XP. Revenue from
Microsoft Great Plains also contributed to the growth.
Europe, Middle East, and Africa Region revenue was $1.11 billion, increasing 2%
compared to $1.09 billion in the first quarter of the prior year. The results
were largely affected by the weakening of local currencies, which negatively
impacted translated revenue compared to the prior year. Revenue in the region
would have increased 8% compared to the first quarter of fiscal 2001 if foreign
exchange rates were constant with those of the prior year. However, revenue from
Windows 2000 Professional and Server and the .NET Enterprise Server family of
products was very healthy.
Asia Region revenue decreased 15% to $604 million from $708 million in the
September quarter of the prior year. The region's revenue growth rate was
influenced by a sharp decline in consumer PC shipments, which affected the sales
of localized versions of Microsoft Office XP. However, the region reported
strong enterprise licensing revenue growth, particularly in Server Platforms and
.NET Enterprise Servers. Additionally, revenue in the region would have been 9%
higher than the reported revenue if foreign exchange rates were constant with
those of the prior year.
Translated international revenue is affected by foreign exchange rates. The net
impact of foreign exchange rates on revenue was negative in the September
quarter compared to a year ago, due to weaker European and Japanese currencies
versus the U.S. dollar. Had the rates from the prior year's comparable quarter
been in effect in the first quarter of fiscal 2002, translated international
revenue billed in local currencies would have been approximately $140 million
higher. Certain manufacturing, selling, distribution, and support costs are
disbursed in local currencies, and a portion of international revenue is hedged,
thus offsetting a portion of the translation exposure.
Operating Expenses
Effective July 1, 2001, Microsoft adopted Statement of Financial Accounting
Standards (SFAS) 141, Business Combinations, and SFAS 142, Goodwill and Other
Intangible Assets. SFAS 141 requires business combinations to be accounted for
using the purchase method of accounting. It also specifies the types of acquired
intangible assets that are required to be recognized and reported separate from
goodwill. SFAS 142 requires that goodwill and certain intangibles no longer be
amortized, but instead tested for impairment at least annually. There was no
impairment of goodwill upon adoption of SFAS 142. Goodwill amortization was $68
million (pre-tax) in the first quarter of fiscal 2001.
Cost of revenue was $884 million or 14.4% as a percent of revenue in the first
quarter, compared to $825 million or 14.3% as a percent of revenue in the first
quarter of the prior year. Higher support and service costs associated with the
MSN Internet access, MSN network services, and Enterprise services were
partially offset by lower relative costs related to a decline in hardware and
packaged consumer software products revenue and a higher mix of organizational
licensing revenue versus the prior year's comparable quarter.
Research and development expenses in the first quarter increased 6% from the
first quarter of the prior year to $1.01 billion. R&D expenses increased
primarily due to higher headcount-related costs and development costs associated
with upcoming product releases, including Windows XP and Xbox, partially offset
by the discontinuation of goodwill amortization in accordance with SFAS 142 in
fiscal 2002.
Sales and marketing expenses were $1.15 billion in the September quarter, or
18.7% of revenue, compared to $1.04 billion in the first quarter of the prior
year, or 18.0% of revenue. Sales and marketing expenses as a percent of revenue
increased due to higher relative headcount related costs associated with new
sales initiatives, partially offset by lower relative marketing costs.
General and administrative costs were $187 million in the first quarter compared
to $170 million in the comparable quarter of the prior year. General and
administrative costs increased from the first quarter of fiscal 2001, due to
higher headcount-related costs.
Non-operating Items, Investment Income/(Loss), and Income Taxes
Losses on equity investees and other incorporates Microsoft's share of income or
loss from MSNBC, Avanade, and other investments accounted for using the equity
method. Losses on equity investees and other decreased to $30 million in the
first quarter of fiscal 2002, compared to $52 million in the comparable quarter
of fiscal 2001, primarily reflecting a decrease in the number of such
investments compared to the first quarter of fiscal 2001 in addition to the
elimination of amortization of goodwill in accordance with SFAS 142 in fiscal
2002.
In the first quarter, the Company reported $980 million in investment loss. The
loss for the quarter included $612 million of bond portfolio return and dividend
income, offset by $1.59 billion in net recognized losses. Net
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recognized losses included a write down for other-than-temporary impairments of
$1.82 billion, primarily as a result of further declines in the fair values of
European cable and telecommunications holdings, net realized gains on equity
securities of $391 million, and $157 million in net losses attributable to
derivative instruments. In the prior year comparable quarter, the Company
reported $1.13 billion in investment income, which included $499 million of bond
portfolio income and dividends and $628 million of net recognized gains.
Effective July 1, 2000, Microsoft adopted SFAS 133, Accounting for Derivative
Instruments and Hedging Activities, which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts and for hedging activities. All derivatives, whether
designated in hedging relationships or not, are required to be recorded on the
balance sheet at fair value. If the derivative is designated as a fair value
hedge, the changes in the fair value of the derivative and the hedged item are
recognized in earnings. If the derivative is designated as a cash flow hedge,
changes in the fair value of the derivative are recorded in other comprehensive
income (OCI) and are recognized in the income statement when the hedged item
affects earnings.
The adoption of SFAS 133 on July 1, 2000, resulted in a cumulative pre-tax
reduction to income of $560 million ($375 million after-tax) and a cumulative
pre-tax reduction to OCI of $112 million ($75 million after-tax). The reduction
to income was mostly attributable to a loss of approximately $300 million
reclassified from OCI for the time value of options and a loss of approximately
$250 million reclassified from OCI for derivatives not designated as hedging
instruments. The reduction to OCI was mostly attributable to losses of
approximately $670 million on cash flow hedges offset by the reclassifications
out of OCI of the approximately $300 million loss for the time value of options
and the approximately $250 million loss for derivative instruments not
designated as hedging instruments.
The effective tax rate for fiscal 2002 is estimated to be 32%. The effective tax
rate for fiscal 2001 was 33%.
Financial Condition
Cash and short-term investments totaled $36.16 billion as of September 30, 2001.
The growth in the cash balance during the quarter included net purchases of
approximately $1.2 billion in short-term investments near September 30 as part
of Microsoft's normal management of the investment portfolio, which were settled
after the balance sheet date. The Company is required to recognize the
investments on the trade date rather than the settlement date, accordingly there
was a corresponding increase in other current liabilities.
Cash flow from operations was $3.39 billion in the September quarter of fiscal
2002, compared to $2.96 billion in the September quarter of fiscal 2001. The
increase was primarily attributable to the growth in operating income and other
changes in working capital in the September quarter of fiscal 2002. Cash used
for financing was $734 million in the September quarter of fiscal 2002, a
decrease of $562 million from the first quarter of the prior year, reflecting a
decrease in common stock repurchased. During the September quarter of fiscal
2002, the Company repurchased 21.6 million shares of common stock under its
share repurchase program, compared to 25.5 million shares repurchased in the
first quarter of the prior year. Cash used for investing was $3.47 billion in
the September quarter of fiscal 2002, a decrease of $467 million from the first
quarter of the prior year.
Microsoft has no material long-term debt. Stockholders' equity at September 30,
2001 was $48.51 billion. Microsoft will continue to invest in sales, marketing,
and product support infrastructure. Additionally, research and development
activities will include investments in existing and advanced areas of
technology, including using cash to acquire technology. Additions to property
and equipment will continue, including new facilities and computer systems for
R&D, sales and marketing, support, and administrative staff. Commitments for
constructing new buildings were $93 million on September 30, 2001. Since fiscal
1990, Microsoft has repurchased 876 million common shares while 2.15 billion
shares were issued under the Company's employee stock option and purchase plans.
Management believes existing cash and short-term investments together with funds
generated from operations should be sufficient to meet operating requirements.
The Company's cash and short-term investments are available for strategic
investments, mergers and acquisitions, other potential large-scale needs and to
fund the share repurchase program. Microsoft has not paid cash dividends on its
common stock.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to foreign currency, interest rate, and securities price
risks. A portion of these risks is hedged, but fluctuations could impact the
Company's results of operations and financial position. The Company hedges the
exposure of accounts receivable and a portion of anticipated revenue to foreign
currency fluctuations, primarily with option contracts. The Company monitors its
foreign currency exposures daily to maximize the overall effectiveness of its
foreign currency hedge positions. Principal currencies hedged include the Euro,
Japanese yen, British pound, and Canadian dollar. Fixed income securities are
subject to interest rate risk. The portfolio is diversified and consists
primarily of investment grade securities to minimize credit risk. The Company
routinely uses options to hedge its exposure to interest rate risk in the event
of a catastrophic increase in interest rates. Many securities held in the
Company's equity and other investments portfolio are subject to price risk. The
Company uses options to hedge its price risk on certain highly volatile equity
securities.
The Company uses a value-at-risk (VAR) model to estimate and quantify its market
risks. The VAR model is not intended to represent actual losses in fair value,
but is used as a risk estimation and management tool. Assumptions applied to the
VAR model at June 30, 2001 and September 30, 2001 include the following: normal
market conditions; Monte Carlo modeling with 10,000 simulated market price
paths; a 97.5% confidence interval; and a 20-day estimated loss in fair value
for each market risk category. Accordingly, 97.5% of the time the estimated
20-day loss in fair value would not exceed $66 million and $146 million at June
30, 2001 and September 30, 2001 for foreign currency denominated investments and
accounts receivable, $363 million and $405 million at June 30, 2001 and
September 30, 2001 for interest-sensitive investments, or $520 million and $293
million at June 30, 2001 and September 30, 2001 for equity securities.
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Part II. Other Information
Item 1. Legal Proceedings
See notes to financial statements.
Item 6. Exhibits and Reports on Form 8-K
(A) Exhibits
None
(B) Reports on Form 8-K
The Company filed no reports on Form 8-K during the quarter ended September 30,
2001.
Items 2, 3, 4, and 5 are not applicable and have been omitted.
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Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Microsoft Corporation
Date: October 26, 2001 By: /s/ John G. Connors
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John G. Connors
Senior Vice President; Chief Financial
Officer
(Principal Financial and Accounting
Officer and Duly Authorized Officer)
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