MSFT

Microsoft Corporation 10-Q Summary: Quarter Ended March 31, 1998

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 1998 (Q3 Fiscal 1998) and the nine months ended March 31, 1998. Microsoft Corporation develops, manufactures, licenses, and supports software products including operating systems (Windows), server applications, productivity suites (Office), and Internet technologies. The company also engages in interactive content efforts and sells PC input devices.

Key Financial Metrics

Margins (Q3 1998): Operating margin was 51.1%; Net income margin was 35.4%. Cost of revenue as a percent of revenue declined to 8.4% from 9.3% in the prior year.

Material Changes vs. Prior Period

• Revenue Growth: Q3 revenue increased 18% year-over-year; nine-month revenue increased 28%. Growth was driven by Windows 32-bit OS adoption and Microsoft Office 97 deployment.
• Acquisition Impact: The acquisition of WebTV Networks resulted in a one-time write-off of $296 million for in-process technology, impacting net income and effective tax rates.
• Expense Trends: Research and development expenses increased 21% in Q3 and 27% year-to-date due to higher headcount and third-party development costs. Sales and marketing expenses as a percentage of revenue decreased.
• Foreign Exchange: A strengthening U.S. dollar negatively impacted translated revenue in Europe and Other International regions, reducing reported revenue by approximately $126 million combined.
• Stock Repurchases: The company repurchased 7.4 million shares on the open market and 21.2 million shares via forward purchase arrangements during the first three quarters of fiscal 1998.

Guidance, Outlook, Risks, and Contingencies

Outlook: Management expects existing cash and short-term investments, combined with funds from operations, to be sufficient for the next 12 months. The company plans to continue investing in R&D, sales infrastructure, and strategic acquisitions. No specific forward-looking revenue guidance was provided in this filing.

Legal Proceedings:

• Sun Microsystems: Sun sued Microsoft regarding Java technology compatibility and licensing. A court issued a preliminary injunction preventing Microsoft from using the Java Compatibility Logo on Internet Explorer 4.0. Microsoft is appealing and has counterclaimed.
• DOJ Antitrust: The U.S. Department of Justice filed a petition alleging Microsoft violated a 1994 consent decree by bundling Internet Explorer with Windows 95. A preliminary injunction was issued requiring Microsoft not to condition Windows licensing on browser licensing. Microsoft has appealed and obtained a stay regarding Windows 98.
• State Attorneys General: Investigations are ongoing, with potential for future antitrust litigation.

Year 2000 (Y2K): Microsoft is assessing product and internal system readiness. While management believes resolving Y2K issues will not have a material adverse financial impact, the company notes that variability in compliance definitions may lead to lawsuits with unestimable outcomes.

Investor Verification Checklist

• Verify the impact of the $296 million WebTV in-process technology write-off on net income and tax rates.
• Monitor the status of the DOJ antitrust case and the Sun Microsystems Java litigation, specifically regarding potential injunctions on Windows 98 and Internet Explorer distribution.
• Assess the sustainability of revenue growth given the noted slowing in OEM channel growth and the negative impact of foreign exchange rates.
• Review the company's Y2K compliance strategy and potential liability exposure from customer lawsuits regarding software compatibility.
• Confirm the effectiveness of the stock repurchase program in offsetting dilution from employee stock option grants.