For Release 1:30 p.m. PST
January 18, 2000
Microsoft Announces Record Quarterly Revenue and Income
Company to Transform Around Internet User Experience
And Next Generation Windows Services
REDMOND, Wash.— Jan. 18, 2000 — Microsoft Corp. today announced record revenue of $6.11 billion for the quarter ended Dec. 31, 1999, an 18 percent increase over the $5.20 billion for the same quarter last year. Net income and diluted earnings per share were $2.44 billion and $0.44, a 22 percent increase over the $0.36 diluted earnings per share reported for the corresponding quarter last year.
This quarter’s earnings include a one-time charge of approximately $0.03 per share related to the settlement of a lawsuit by Caldera Inc. Excluding this charge, diluted earnings per share grew 31 percent to $0.47, from $0.36.
“We are very pleased with this quarter’s results, which came in as expected reflecting solid customer demand from around the world, particularly in Asia. Office 2000 and SQL Server 7.0 continued to perform strongly, but we experienced slowing demand for business PCs during the quarter,” said John Connors, chief financial officer at Microsoft. “With the upcoming launch of Windows 2000 we are extremely excited to usher in a new era in personal and business computing. However, we remain cautious in our expectations for near-term PC demand and corporate software spending, and continue to anticipate moderate revenue growth through the remainder of fiscal 2000.”
On Dec. 15, 1999, Microsoft released to manufacturing the Microsoft® Windows® 2000 Professional, Windows 2000 Server and Windows 2000 Advanced Server operating systems, and announced broad availability on Feb. 17, 2000.
“Windows 2000 is the most reliable, highest-performing operating system in our company's history, and provides a platform to support customers’ needs for the 21st century,” said Jim Allchin, group vice president of Platforms at Microsoft. “The completion of Windows 2000 represents a phenomenal team effort and would not have been possible without the amazing contributions of our employees, customers and partners across the industry. Windows 2000 is the premier platform for enabling exciting new Internet computing solutions, and addresses the full range of business customer needs, from laptops and desktops to high-end servers.”
Microsoft recently announced plans to assemble the first Internet-based platform of next generation Windows services, with Microsoft Windows 2000 as a crucial building block of the company’s new strategy focusing on software services.
“Software is the key to the future. It will drive and accelerate innovations in hardware, wireless, broadband, e-commerce and other fields,” said Steve Ballmer, president and CEO at Microsoft. Next generation Windows services will power new products and services and incorporate features and capabilities such as a new user interface, natural language processing, application development approach, schema and new file system — all of which have been in development.
During the quarter Microsoft announced strategic alliances with RadioShack and Best Buy Company Inc. aimed at accelerating the adoption of Web technologies and consumer connections to the Internet. The agreement with RadioShack will establish a Microsoft “store within a store” in as many as 7,000 RadioShack locations across the nation. Customers will be able to see demonstrations of a broad range of solutions and services based on Microsoft technologies, and sign up for narrowband dial-up or broadband Internet access via MSN™ or WebTV Network™ services. The alliance with Best Buy will include significant joint marketing efforts and the demonstration and sale of MSN Internet Access plus the full range of Microsoft’s connectivity solutions at more than 350 Best Buy stores.
Microsoft also formed a strategic alliance with Ericsson Mobile Communications to develop end-to-end solutions for the wireless Internet, as part of a shared vision of enabling convenient and fast access to information any time, anywhere and from any device. Ericsson will provide its Wireless Application Protocol (WAP) stack to Microsoft and will adopt Microsoft Mobile Explorer for use in its feature phones. Microsoft Mobile Explorer is a modular mobile phone platform for enabling secure corporate data access, e-mail, Internet, location-based services and electronic commerce from feature phones and smart phones.
This press release contains statements that are forward-looking. These statements are based on current expectations that are subject to risks and uncertainties. Actual results will vary because of factors such as PC shipment growth; technological shifts; customer demand; competitive products and pricing; product mix; product ship schedules; life cycles; the impact that year 2000 issues may have on demand for Microsoft’s products and services; terms and conditions; litigation; and other issues discussed in the company’s Form 10-K.
Founded in 1975, Microsoft (Nasdaq “MSFT”) is the worldwide leader in software for personal and business computing. The company offers a wide range of products and services designed to empower people through great software — any time, any place and on any device.
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Some information contained in this document relates to prereleased product which may be substantially modified before first commercial release. Accordingly, the information may not accurately describe or reflect the software product when first commercially released. This document is provided for informational purposes only, and Microsoft makes no warranties, express or implied, with respect to this document or the information contained in it.
Microsoft, MSN, WebTV, WebTV Network, and Windows are either registered trademarks or trademarks of Microsoft Corp. in the United States and/or other countries.Other products and company names mentioned herein may be trademarks of their respective owners.
Microsoft Corporation
Financial Highlights
Second Quarter of Fiscal Year 2000
(All growth percentages are comparisons
to the comparable period of fiscal year 1999)
Revenue
Revenue of $6.11 billion in the December quarter of fiscal 2000 increased 18% over the second quarter of fiscal 1999. The revenue growth reflected strong licensing of Microsoft® Office 2000. Partially offsetting this growth was moderate growth for Windows® operating systems, due to soft corporate demand for PCs and software combined with the expected slowness of demand for Windows NT® Server and Windows NT Workstation in anticipation of the launch of Windows 2000.
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. Revenue increased 28% to $2.80 billion in the December quarter. Revenue from Microsoft Office integrated suites, including the Premium, Professional, Small Business, and Standard Editions was very strong, reflecting healthy demand for Microsoft Office 2000. Revenue also included the recognition of $64 million of previously unearned revenue, due to fulfillment of the Microsoft Office 2000 Technology Guarantee. Microsoft SQL Server 7.0 revenue continued to be robust. Revenue from Microsoft Exchange Server and software developer tools was steady.
Windows Platforms products include primarily Windows 98, Windows NT Workstation, and Windows NT Server. Revenue of $2.44 billion in the second quarter represented growth of 6% over the prior year. Windows-based desktop operating systems revenue grew slightly. Units licensed through the PC original equipment manufacturer (OEM) channel reflected slower growth of corporate PC purchases. Additionally, consumer PC purchases through traditional retail channels were moderate and revenue from retail versions of Windows 98 decreased. This decrease reflected the strong comparable quarter of the prior year which included significant revenue from Windows 98 after its launch in June 1998. Windows NT Workstation and Windows NT Server revenue growth slowed, reflecting customer anticipation of the next version of the operating system, Windows 2000.
Consumer and Otherproducts include learning and entertainment software; PC input devices; training and certification fees; consulting; and the online services. Revenue in the December quarter was $872 million, up 23% from the comparable quarter of fiscal 1999. Learning and entertainment software posted superb growth, reflecting a strong seasonal quarter. Hardware product revenue grew moderately. Online advertising and access revenue rose substantially.
Distribution Channels
Microsoft distributes its products primarily through OEM licenses, organizational licenses, and retail packaged products. OEM channel revenue represents license fees from original equipment manufacturers who pre-install Microsoft products, primarily on PCs. Microsoft has three major geographic sales and marketing organizations: the South Pacific and Americas Region; the Europe, Middle East, and Africa Region; and the Asia Region. Sales of organizational licenses and packaged products via these channels are primarily to and through distributors and resellers.
OEM second quarter revenue of $1.87 billion represented an increase of 4% over the comparable quarter of fiscal 1999. There were several reasons for the relatively low growth rate. The second quarter of fiscal 1999 was an unusually high-growth quarter for OEM revenue, having grown 48% over the comparable quarter of fiscal 1998. PC shipment growth was moderate in the December quarter of fiscal 2000, with particular slowness in corporate PC demand. Average revenue per license declined slightly, due in part to a mix shift to high-volume multi-national PC manufacturers from low-volume system builders. Additionally, demand for Windows NT Workstation moderated in anticipation of the launch of Windows 2000 Professional Version.
South Pacific and Americas Region revenue in the December quarter increased 26% to $2.21 billion. Several products had strong revenue growth, including Office; SQL Server; learning and entertainment software; and online services. Organizational licensing activity was moderate. Revenue growth was particularly strong in the South Pacific, moderate in the United States and Canada, and slower in Latin America.
Europe, Middle East, and Africa Region second quarter revenue of $1.43 billion was up 14% compared to the second quarter of fiscal 1999. Microsoft Office exhibited the highest absolute revenue growth of the Company’s products in the region. Revenue growth, measured in constant dollars, was moderate in the United Kingdom, France, and Germany. Revenue in the region would have grown 22% if foreign exchange rates were constant with those of a year ago. Weakening local currencies negatively impacted translated revenue compared to the prior year.
Asia Region revenue in the December quarter of $606 million increased 56% from the second quarter of the prior year, reflecting improved local economic conditions and strong revenue from localized versions of Microsoft Office 2000, particularly in Japan. Revenue grew strongly in most countries in the Asia Region.
Translated international revenue is affected by foreign exchange rates. The impact of foreign exchange rates on revenue was negative in the December quarter compared to a year ago, as European currencies were very weak versus the U.S. dollar, offset partially by stronger Japanese yen versus the U.S. dollar. Had the rates from the prior year been in effect in the second quarter of fiscal 2000, translated international revenue billed in local currencies would have been $35 million higher. 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 APB 25 to account for ESOs, which generally does not require income statement recognition of options granted at the market price on the date of issuance, and discloses the Black-Scholes value of option grants. A new interpretation of APB 25 requires recognition of the FICA and Medicare expense paid on option exercises. Other 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, or accelerating the vesting of options. These costs were reflected in each operating expense line item in the income statement in the second quarter and totaled $170 million.
Cost of revenue as a percent of revenue was 12.4% in the second quarter, down from 15.2% in the second quarter of the prior year. The percentage decrease resulted primarily from the trend in mix shift to organizational licenses and lower costs associated with WebTV® Networks’ operations.
Research and development expenses increased 27% from the second quarter of the prior year to $911 million, driven primarily by higher development headcount-related costs, including various charges related to employee stock options.
Sales and marketing expenses were $1.03 billion in the December quarter, which represented 16.8% of revenue, compared to 15.3% in the second quarter of the prior year. Sales and marketing expenses as a percent of revenue increased due to both higher relative marketing costs and sales expenses, including certain employee stock option expenses.
General and administrative costs were $506 million in the second quarter compared to $149 million in the December quarter of the prior year. The increase for the quarter was due primarily to the settlement of the lawsuit with Caldera, Inc. Costs also included increased legal fees and certain stock option-related charges.
Other expenses and income include miscellaneous items, including gains on foreign exchange and the recognition of Microsoft’s share of joint venture activities, including Transpoint and the MSNBC entities.
Nonoperating Items and Income Taxes
Second quarter investment income increased to $773 million from $337 million in the second quarter of the prior year. The increase was due to realized gains of approximately $400 million and the larger investment portfolio generated by cash from operations. Realized gains in the second quarter of fiscal 1999 were approximately $70 million.
The effective tax rate for fiscal 2000 is 34%. Excluding the tax impact of the gain on the sale of Softimage, the effective tax rate for fiscal 1999 was 35%.
Unearned Revenue
A portion of Microsoft's revenue is earned ratably over the product life cycle or, in the case of subscriptions, over the period of the license agreement.
End users receive certain elements of the Company's products over a period of time. These elements include browser technologies and technical support. Consequently, Microsoft’s earned revenue reflects the recognition of the fair value of these elements over the product's life cycle. The percentage of revenue recognized ratably ranges from approximately 15% to 25% of Windows desktop operating systems and approximately 10% to 20 % of desktop applications, depending on the terms and conditions of the license and prices of the elements. Product life cycles are currently estimated at three years for Windows operating systems and 18 months for desktop applications. The Company also sells subscriptions to certain products via maintenance and certain organization license agreements. At December 31, 1999, unearned revenue was $4.26 billion. Windows Platforms products unearned revenue was $2.40 billion and unearned revenue associated with Productivity Applications and Developer products totaled $1.70 billion. During the second quarter, reported revenue included $64 million related to the fulfillment of Office 2000 Technology Guarantee coupons. Unearned revenue for Productivity Applications and Developer products was reduced accordingly. Unearned revenue for other miscellaneous programs totaled $161 million at December 31, 1999.
Balance Sheet and Cash Flow
Cash and short-term investments totaled $17.84 billion as of December 31, 1999. Cash flow from operations in the December quarter was $2.15 billion.
Equity and other investments at December 31, 1999 were $19.80 billion. The sequential increase was due to new investment purchases and a net increase in the market value of publicly traded securities in the portfolio of $3.8 billion.
During the December quarter, the Company repurchased 42.6 million shares of common stock under its stock repurchase program for $3.8 billion. To enhance its stock repurchase program, Microsoft sold equity put warrants. These put warrants entitle the purchasers to sell shares of Microsoft common stock to the Company on certain dates at specified prices. On December 31, 1999, 163 million warrants were outstanding with strike prices ranging from $69 to $78 per share and expirations ranging from June 2000 to December 2002. These put warrant contracts permit a net-share settlement at the Company’s option.
The Company’s convertible preferred stock matured on December 15, 1999. Each preferred share was converted into 1.1273 common shares.
Employee Stock Options (ESOs)
The Company encourages broad-based employee ownership of Microsoft stock through an ESO program in which the majority of employees are eligible to participate. At December 31, 1999, 692 million vested and unvested options were outstanding, compared to 5,177 million common shares outstanding.
The Company follows APB Opinion 25 to account for its ESO plans in its published financial statements. Earnings per share calculations reflect exercised ESOs and the effect of outstanding ESOs under the treasury stock method. In addition, as required by Statement of Financial Accounting Standard 123 (SFAS 123), the Company discloses the value of ESO grants using the Black-Scholes option valuation method and the proforma impact of expensing such value over the vesting period of the ESOs in the notes to its annual financial statements.
ESOs are a claim on the increase in the value of the Company and Microsoft does not believe that there is a single income statement presentation that adequately measures that claim. Since employees cannot sell their ESOs, there is no subsequent transaction that provides validation of the Black-Scholes value of the ESO expensed over the vesting period. Although not currently its practice, the Company could "hedge" its ESOs by purchasing offsetting call options when ESOs are granted. The assumed hedge with a third party provides a theoretical basis for measuring and recognizing the cost of ESOs when granted.