MSFT

Microsoft Corporation 10-Q Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended December 31, 1998 (Second Quarter of Fiscal Year 1999) and the six months ended on that date. Microsoft Corporation develops, manufactures, licenses, and supports software products including operating systems, server applications, productivity tools, and interactive media. The company reported strong revenue growth driven by the adoption of Windows 32-bit operating systems and Microsoft Office, alongside increased organizational licensing.

Key Financial Metrics

Margins (Q2 1999): Operating margin was approximately 55%. Cost of revenue was 8.8% of revenue. Sales and marketing expenses were 19.0% of revenue.

Material Changes vs. Prior Period

• Revenue Growth: Q2 1999 revenue increased 38% year-over-year to $4.94 billion. Six-month revenue grew 32% to $8.89 billion.
• Profitability: Net income for Q2 1999 rose 75% to $1.98 billion compared to $1.13 billion in the prior year quarter.
• Product Mix: Platforms revenue grew 50% to $2.32 billion, driven by Windows NT and Windows 98. Applications and Tools revenue grew 27% to $2.15 billion, led by Microsoft Office suites.
• Unusual Items: The six-month period included a $160 million pretax gain from the sale of the Softimage subsidiary. The prior year period included a $296 million write-off for WebTV in-process technology.
• Geographic Performance: Revenue grew strongly in the Americas and Europe. Asia revenue was flat year-over-year due to economic issues and weak currencies in Japan and Southeast Asia.

Guidance, Outlook, and Risks

Management Commentary: Management attributes growth to software license volume increases and organizational licensing surges, partly driven by Year 2000 "lockdowns" where customers finalized IT spending before remediation efforts. The company maintains a strong liquidity position with $19.24 billion in cash and short-term investments and no material long-term debt.

Stock Repurchases: Microsoft continues to repurchase common stock to offset dilution from employee stock options. In the first half of fiscal 1999, the company repurchased 7.8 million shares in the open market and utilized structured repurchases.

Legal Proceedings:

• Sun Microsystems: A preliminary injunction was granted against Microsoft regarding Java compatibility. Microsoft is complying with the order while appealing to the 9th Circuit.
• DOJ Antitrust: The U.S. Department of Justice and 20 state Attorneys General filed antitrust suits alleging violations of the Sherman Act regarding the "tying" of Internet Explorer to Windows. Trial began in October 1998.
• Caldera: A lawsuit alleging Sherman Act violations regarding MS-DOS and Windows licensing is scheduled for trial in June 1999.

Year 2000 Risk: Management believes critical systems will be ready by the Year 2000 and that remediation costs are not material. However, the company notes that variability in compliance definitions may lead to lawsuits, the impact of which is not estimable.

Investor Verification Checklist

• Revenue Recognition: Verify the impact of unearned revenue (approx. $3.55 billion at Dec 31, 1998) and the ratable recognition policies for Windows and Office products.
• Legal Exposure: Monitor the status of the DOJ antitrust trial and the Sun Microsystems Java injunction appeal, as outcomes could affect product distribution and licensing.
• Year 2000 Remediation: Assess the company's progress in testing and remediating internal systems and third-party supply chains against the stated June/September 1999 deadlines.
• Stock Dilution: Review the balance between stock repurchases and the issuance of shares for employee stock options (market value of outstanding options was $60 billion as of Dec 31, 1998).
• Geographic Currency Impact: Evaluate the sensitivity of international revenue to foreign exchange rates, particularly in Asia and Europe.