REVENUE
Our revenue growth rate was 10% in
fiscal 2001, 12% in fiscal 2002, and 13% in fiscal 2003. Revenue growth in
fiscal 2003 was driven primarily by multi-year licensing that occurred before
the transition to our new licensing program (Licensing 6.0) in the first
quarter of fiscal 2003. Prior to the July 31, 2002 transition date to Licensing 6.0, we
experienced significant growth in multi-year licensing arrangements as
customers enrolled in our maintenance programs, including Upgrade Advantage and
Software Assurance. The revenue growth also reflected a $933 million or 13%
increase associated with OEM licensing of Microsoft Windows operating systems
and a $309 million or 23% increase in revenue from Microsoft Xbox video game
consoles. Revenue growth in fiscal 2002 was led by the addition of $1.35
billion of Xbox video game system revenue and $1.20 billion of revenue growth
from Microsoft Windows XP Professional and Home operating systems. Revenue
growth in fiscal 2001 was driven primarily by licensing of Microsoft Windows
2000 Professional with $1.01 billion growth in revenue from Professional
operating systems, and Server and Tools revenue growth of $852 million.
During the second quarter of fiscal
2002, we launched a new licensing program, Licensing 6.0, for volume licensing
customers. Licensing 6.0 simplifies and improves our volume licensing program
with Software Assurance, which gives customers the right to install any new
release of products covered in the licensing agreement during the term of their
coverage. The level of customer adoption of our new volume licensing programs
will affect the mix of multi-year licensing agreements with a resulting impact
on the timing of revenue recognition. In addition, the timing and extent of a
recovery in consumer and corporate spending on PCs and information technology
will be factors affecting revenue growth.
CONSOLIDATED OPERATING INCOME
Operating income grew 6% in fiscal 2001,
2% in fiscal 2002, and 11% in fiscal 2003. In fiscal 2003, the growth in
operating income reflected an increase of $3.82 billion in revenue, partially
offset by an increase of $2.52 billion in operating expenses, primarily related
to employee and related costs associated with additional headcount and
increased legal settlement expenses. In fiscal 2002, the growth in operating
income reflected an increase of $3.07 billion in revenue, substantially offset
by an increase of $2.88 billion in operating expenses, which included the onset
of costs related to Xbox video game systems. In fiscal 2001, the growth in
operating income reflected an increase of $2.34 billion in revenue, partially
offset by an increase of $1.63 billion in operating expenses.
SEGMENT PRODUCT REVENUE/OPERATING INCOME (LOSS)
We revised our segments for fiscal year 2003. Our seven
segments are:
·
Client
·
Server
and Tools
·
Information
Worker
·
Microsoft
Business Solutions
·
MSN
·
Mobile
and Embedded Devices
·
Home
and Entertainment
The revenue and operating
income/(loss) amounts in this MD&A are presented in accordance with U.S.
GAAP. Segment Information appearing in Note 21 of the Notes to Financial
Statements are presented in accordance with SFAS 131, Disclosures about
Segments of an Enterprise and Related Information.
The following table presents our segment revenue and
operating income, determined in accordance with U.S. GAAP:
|
(In
millions)
|
|
Revenue
|
|
Operating Income/(Loss)
|
|
Year
Ended June 30
|
|
2002
|
|
2003
|
|
2002
|
|
2003
|
|
|
|
|
|
|
|
Client
|
|
$ 9,360
|
|
$ 10,394
|
|
$ 7,576
|
|
$ 8,400
|
|
Server and Tools
|
|
6,157
|
|
7,140
|
|
2,048
|
|
2,457
|
|
Information Worker
|
|
8,212
|
|
9,229
|
|
6,448
|
|
7,037
|
|
Microsoft Business Solutions
|
|
308
|
|
567
|
|
(176)
|
|
(254)
|
|
MSN
|
|
1,571
|
|
1,953
|
|
(641)
|
|
(299)
|
|
Mobile and Embedded Devices
|
|
112
|
|
156
|
|
(157)
|
|
(157)
|
|
Home and Entertainment
|
|
2,453
|
|
2,748
|
|
(874)
|
|
(924)
|
|
Other
|
|
192
|
|
-
|
|
(2,314)
|
|
(3,043)
|
|
Consolidated
|
|
$ 28,365
|
|
$ 32,187
|
|
$ 11,910
|
|
$ 13,217
|
|
|
|
|
|
|
|
|
|
|
|
Client
Client revenue was $8.17 billion,
$9.36 billion, and $10.39 billion in 2001, 2002, and 2003. Client includes
revenue from Windows XP Professional and Home, Windows 2000 Professional, and
other standard Windows operating systems. In 2003, Client revenue growth was
driven by OEM licensing revenue growth of $933 million and a 9 percentage point
increase of the mix of the higher priced Windows Professional operating
systems, the majority of which was in the OEM channel. Windows Professional
revenue growth for fiscal 2003 was $1.59 billion or 31% compared to fiscal
2002, partially offset by a $573 million decline in revenue of
earlier versions of Windows operating
systems. Client operating profit for fiscal 2003 increased 11% primarily as a
result of the 11% growth in revenue, partially offset by an increase in
operating expenses, largely attributed to headcount additions and related
costs.
In fiscal 2002, the growth in Client
revenue reflected strong multi-year licensing revenue growth and a continued
shift of sales to the higher priced Windows 2000 and Windows XP Professional
operating system licensed through OEMs. OEM revenue grew $939 million, despite
a 5% decline in reported OEM unit shipments. Fiscal 2001 revenue growth
reflected the strong adoption of Windows 2000 Professional with professional
operating systems revenue growth of $1.01 billion and a 7 percentage point mix
increase to the higher priced Windows 2000 Professional and Windows NT
Workstation operating systems, and a $91 million increase in revenue from
Windows Me and Windows 98 operating systems.
We do not expect the revenue growth
attributed to the mix toward the higher priced Windows Professional operating
system to continue at previous levels into fiscal 2004. Additionally,
variability between the reported OEM unit shipments and the underlying PC
Market may continue as a result of the transition to new OEM licensing terms at
the beginning of fiscal year 2003, under which OEMs are billed upon their
acquisition of Certificates of Authenticity (COAs) rather than upon the
shipment of PCs to their customers.
Server and Tools
Server and Tools revenue was $5.84
billion, $6.16 billion, and $7.14 billion in 2001, 2002, and 2003. Server and
Tools consists of server software licenses and client access licenses (CALs)
for Windows Server, SQL Server, Exchange Server, and other servers. It also
includes developer tools, training, certification, Microsoft Press, Premier
product support services, and Microsoft consulting services. Total Server and
Tools revenue grew $983 million or 16% in fiscal 2003, driven by an increase in
Windows-based server shipments and growth in SQL Server and Exchange revenue.
Server revenue, including CALs, grew $787 million or 18% from fiscal 2002 as a
result of increased new and anniversary multi-year licensing agreements.
Consulting and Premier product support services increased $91 million or 10%
compared to fiscal 2002. Revenue from developer tools, training, certification,
Microsoft Press and other services increased $105 million or 13%. Server
operating profit for fiscal 2003 grew 20%, primarily as a result of the 16%
increase in revenue.
In fiscal 2002, Server and Tools
revenue increased 5% compared to fiscal 2001. Server revenue, including CALs,
increased 9% versus fiscal 2001, driven by a 5% overall increase in
Windows-based server shipments and increased deployment of Windows 2000 Server.
Consulting and Premier product support services revenue was up $137 million or
17% compared to fiscal 2001, while revenue from developer tools, training,
certification, Microsoft Press and other services was down $183 million or 18%
from fiscal 2001. In fiscal 2001, Server and Tools revenue increased $852
million or 17% versus the prior year, as a result of the continued adoption of
the Microsoft Enterprise Server offerings.
Information Worker
Information Worker revenue was $8.42
billion, $8.21 billion, and $9.23 billion in 2001, 2002, and 2003. Information
Worker includes revenue from Microsoft Office, Microsoft Project, Visio, other
information worker products, SharePoint Portal Server CALs, and professional
product support services. The $1.02 billion or 12% increase in Information
Worker revenue in fiscal year 2003 compared to fiscal 2002, was primarily due
to growth in Office suites revenue associated with new and anniversary
multi-year licensing agreements and a $264 million or 28% increase in revenue
from the combined total of Project, Visio, and other standalone applications.
Information Worker operating profit for fiscal year 2003 grew 9% compared to
fiscal year 2002 led by the 12% increase in revenue, partially offset by a 24%
growth in operating expenses related to headcount additions and marketing expenses.
In fiscal 2002, Information Worker
licensing revenue declined $228 million or 3% during the year due to a shift in
the sales mix to multi-year licensing agreements, which deferred revenue
recognition to future years, and a $294 million or 14% decrease in consumer
purchases in the Asia-Pacific region, most notably Japan, partially offset by a
$189 million or 22% growth in OEM licensing revenue. In fiscal 2001,
Information Worker revenue growth was less than 1% or $30 million.
Microsoft Business Solutions
Microsoft Business Solutions revenue
was $106 million, $308 million, and $567 million in 2001, 2002, and 2003.
Microsoft Business Solutions includes Microsoft Great Plains, Navision, and
bCentral. Microsoft Business Solutions revenue for fiscal 2003 grew
$259 million from fiscal 2002, of which $246 million was attributable to
the acquisition of Navision at the beginning of the fiscal year. Microsoft
Business Solutions operating loss for fiscal 2003 increased 44%, primarily due
to operating losses associated with Navision, increases in sales and marketing
expenses, research and development expenses, and acquisition related costs.
MSN
MSN revenue was $1.32 billion, $1.57
billion, and $1.95 billion in 2001, 2002, and 2003. MSN includes MSN Subscriptions
and MSN Network services. Although total MSN subscribers at the end of fiscal
2003 were flat compared to the end of fiscal 2002, MSN Subscriptions revenue
grew $112 million or 11% in fiscal year 2003 reflecting an increase in the
number of non-promotion subscribers. MSN Network services revenue grew $270
million or 48% in fiscal 2003 as a result of growth in paid search and strong
general advertising sales across all geographic regions. MSN operating loss for
fiscal 2003 decreased 53%, primarily as a result of the growth in revenue and
lower relative subscription acquisition and support costs.
In fiscal 2002, MSN Subscriptions
revenue increased $229 million or 29% as a result of both a higher subscriber
base and higher average revenue per subscriber due to a reduction in
promotional subscriber programs. Revenue from MSN Network services increased
$27 million or 5% led by online advertising. In fiscal 2001, revenue from MSN
Network services grew $197 million or 58% led by online advertising. MSN Subscriptions
revenue also grew $141 million or 22% from fiscal 2000 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.
Mobile and Embedded Devices
Mobile and Embedded Devices revenue was $86
million, $112 million, and $156 million in 2001, 2002, and 2003. Mobile and Embedded Devices includes
Windows Mobile software, Windows Embedded device operating systems, MapPoint,
and Windows Automotive. Revenue for fiscal 2003 grew $44 million driven by
increased Pocket PC shipments and MapPoint licensing. Operating loss for fiscal
2003 was flat with the prior year as higher marketing expenses and
headcount-related costs associated with product development offset the growth
in revenue. Prior year revenue and operating loss for Mobile and Embedded Devices have been
restated to reflect the reorganizations of MapPoint from Information Worker and
Windows embedded device operating systems from Client to Mobile and Embedded Devices.
Home and Entertainment
Home and Entertainment revenue was
$1.14 billion, $2.45 billion, and $2.75 billion in 2001, 2002, and 2003. Home
& Entertainment includes the Xbox video game system, PC games, consumer software
and hardware, and TV platform. Home and Entertainment revenue increased $295
million, as a result of sales of Xbox video game systems and related games
which were available for all of fiscal 2003. Xbox revenue grew $309 million or
23% in fiscal 2003 reflecting a $779 million increase from higher volumes for
Xbox consoles, games, and peripherals partially offset by a $470 million
decrease due to price changes. Revenue from consumer hardware and software and
PC games declined $14 million or 1% in fiscal 2003. Operating loss for fiscal
2003 increased 6% from the prior year as the product costs associated with the
increased Xbox console sales and increased marketing expense more than offset
the 12% increase in revenue.
In fiscal 2002, Home and Entertainment
revenue growth from fiscal 2001 stemmed from $1.35 billion of sales of the Xbox
video game system released in fiscal 2002. Learning and productivity software
revenue and PC and online games declined $39 million or 3% in fiscal 2002
compared to fiscal 2001. In fiscal 2001, Home and Entertainment revenue
declined $214 million or 16% from fiscal 2002.
Other
Revenue in the Other segment
represents our majority ownership of Expedia, Inc., which was sold in February
2002, resulting in a decline in revenue from fiscal 2001. Acquisitions of
Travelscape.com and VacationSpot.com by Expedia, Inc. in fiscal 2001 and
increased product offerings from Expedia led to the strong revenue growth in
fiscal 2001.
Operating loss includes Expedia, Inc.
revenue and operating expenses, general and administrative expenses ($1.55
billion in 2002 and $2.10 billion in 2003), broad-based research and
development expenses ($202 million in 2002 and $210 million in 2003), and
certain corporate level sales and marketing costs ($526 million in 2002 and
$688 million in 2003).
Foreign Currencies Impact
Our operating results are affected by
foreign exchange rates. Approximately 27%, 25%, and 28% of our revenue was
collected in foreign currencies during 2001, 2002, and 2003. Had the rates from
fiscal 2002 been in effect in fiscal 2003, translated international revenue
billed in local currencies would have been approximately $700 million lower.
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
Cost of Revenue
Cost of revenue includes
manufacturing and distribution costs for products and programs sold, operation
costs related to product support service centers and product distribution
centers, costs incurred to support and maintain Internet-based products and
services, and costs associated with the delivery of consulting services. Cost
of revenue as a percent of revenue was 13.7% in 2001, 18.3% in 2002, and 17.7%
in 2003. For fiscal 2003, cost of revenue was $5.69 billion compared to $5.19
billion in fiscal 2002. The primary driver of the decrease as a percentage of
revenue in fiscal 2003 was a 0.2 percentage point decrease from Home and
Entertainment products due to lower volumes and improved margins of Xbox video
game consoles and a 0.4 percentage point decrease from MSN product and service
costs in fiscal 2003 compared to fiscal 2002.
Cost of revenue in fiscal 2002 was
$5.19 billion compared to $3.46 billion in fiscal 2001. The increase as a
percentage of revenue in fiscal 2002 was due to an increase of 5.3 percentage
points from Home and Entertainment primarily due to costs related to Xbox,
partially offset by a 0.7 percentage point decrease due to a higher mix of
revenue from licensing business. In fiscal 2001, cost of revenue was $3.46
billion, an increase of $453 million compared to fiscal 2000. The higher sales
associated with MSN Subscription and MSN Network services resulting in
increased support and service costs drove 0.4 of the 0.6 percentage point
increase in total costs as a percentage of revenue.
Research and Development
Research and development expenses
include payroll, employee benefits, and other headcount-related costs
associated with product development. Research and development expenses also
include third-party development and programming costs, localization costs
incurred to translate software for international markets, and the amortization
of purchased software code and services content. Research and development
expenses for fiscal 2003 were $4.66 billion, an increase of 8% compared to
fiscal 2002. The increase reflects a 7% increase in headcount-related costs, a
25% increase in third-party product development costs, and a 29% increase in
testing laboratory equipment and expense. In fiscal 2002, research and
development expenses were $4.31 billion compared to $4.38 billion in fiscal
2001. The decrease from fiscal 2001 was due to the discontinuation of
amortization of goodwill in accordance with SFAS 142, Goodwill and Other
Intangible Assets, $272 million which offset the 15% growth in
headcount-related costs. In fiscal 2001, research and development expenses were
$4.38 billion, an increase of 16% compared to fiscal 2000. The increase in
research and development expenses resulted from a 11% increase in
headcount-related costs and a 23% increase in investments in new product
development.
Sales and Marketing
Sales and marketing expenses include
payroll, employee benefits, and other headcount-related costs associated with
sales and marketing personnel and advertising, promotions, tradeshows,
seminars, and other programs. Sales and marketing expense as a percentage of
revenue was 19.3% in 2001, 19.1% in 2002, and 20.3% in 2003. Sales and
marketing expenses were $6.52 billion in 2003, compared to $5.41 billion in
fiscal 2002. The increase in absolute dollars was due to a 20% increase in
sales expenses related to headcount additions, principally related to the Enterprise and Small/Medium Business sales
forces, and a 21% increase in marketing expenses.
In fiscal 2002, sales and marketing
expenses were $5.41 billion, an increase of 11% from fiscal 2001. The sales and
marketing expenses in absolute dollars increased due to a 20% increase in
headcount-related costs partially offset by a 25% decline in MSN customer
acquisition marketing costs and a 4% decline in all other marketing costs. In
fiscal 2001, sales and marketing expenses were $4.89 billion compared to $4.13
billion in fiscal 2000. The 18% increase in sales and marketing from fiscal
2000 was primarily due to a 21% growth in headcount-related costs, and to a
lesser extent, a 3% growth in higher marketing and sales expenses associated with
MSN and other new sales initiatives.
General and Administrative
General and administrative costs
include payroll, employee benefits, and other headcount-related costs
associated with the finance, legal, facilities, certain human resources, other
administrative headcount, and legal and other administrative fees. General and
administrative costs in fiscal 2003 increased $554 million due to a charge of
$750 million related to a settlement with AOL/Time Warner in the fourth quarter
of 2003 and also due to a $256 million charge reflecting an increase in our
estimate of costs related to resolving pending state antitrust and unfair
competition consumer class action lawsuits. General and administrative expenses
in fiscal 2002 increased due to a charge of approximately $660 million for
estimated expenses related to resolving pending state antitrust and unfair
competition consumer class action lawsuits and a 10% increase in
headcount-related costs. In fiscal 2001, general and administrative costs
decreased due to a lawsuit settlement charge recorded in fiscal 2000, partially
offset by a 3% growth in headcount-related costs.
NON-OPERATING ITEMS, INVESTMENT
INCOME/(LOSS), AND INCOME TAXES
Non-operating items
Losses on equity investees and other
consist of our share of income or loss from investments accounted for using the
equity method, and income or loss attributable to minority interests. The
decrease in losses on equity investees and other in fiscal 2003 and 2002 was
due to the divestiture of certain equity investments in fiscal 2002 in
conjunction with the underlying performance of such entities. The increase in
losses on equity investees and other in fiscal 2001 reflected an increase in
the number of such investments during the year.
Investment Income/(Loss)
We recorded net investment income/(loss) in each year as
follows:
|
(In
millions)
|
|
|
|
|
|
|
Year
Ended June 30
|
2001
|
|
2002
|
|
2003
|
|
|
|
|
|
|
Dividends
|
$ 377
|
|
$ 357
|
|
$ 260
|
|
Interest
|
1,808
|
|
1,762
|
|
1,697
|
|
Net recognized gains/(losses) on investments:
|
|
|
|
|
|
|
Net gains on the sales of investments
|
3,175
|
|
2,379
|
|
909
|
|
Other-than-temporary impairments
|
(4,804)
|
|
(4,323)
|
|
(1,148)
|
|
Net unrealized losses attributable to derivative
instruments
|
(592)
|
|
(480)
|
|
(141)
|
|
Net recognized gains/(losses) on investments
|
(2,221)
|
|
(2,424)
|
|
(380)
|
|
Investment income/(loss)
|
$ (36)
|
|
$ (305)
|
|
$ 1,577
|
Investments are considered to be
impaired when a decline in fair value is judged to be other-than-temporary. We
employ a systematic methodology that considers available evidence in evaluating
potential impairment of our investments. If the cost of an investment exceeds
its fair value, we evaluate, among other factors, general market conditions,
the duration and extent to which the fair value is less than cost, as well as
our intent and ability to hold the investment. We also consider specific
adverse conditions related to the financial health of and business outlook for
the investee, including industry and sector performance, changes in technology,
operational and financing cash flow factors, and rating agency actions. Once a
decline in fair value is determined to be other-than-temporary, an impairment
charge is recorded and a new cost basis in the investment is established.
In fiscal 2003, other-than-temporary
impairments decreased mainly due to the lack of significant continued
impairments in the cable and telecommunications sectors. Interest income
decreased $65 million due to declining interest rates partially offset by a
larger investment portfolio. Dividend income decreased $97 million primarily
related to the exchange of AT&T 5% convertible preferred debt for common
shares of AT&T Corporation during the year.
In fiscal 2002, other-than-temporary
impairments primarily related to our investment in AT&T and other cable and
telecommunication investments. Net gains on the sales of investments included a
$1.25 billion gain on sale of our share of Expedia. Interest and dividend
income decreased $66 million from fiscal 2001 as a result of lower interest
rates and dividend income.
In fiscal 2001, other-than-temporary
impairments primarily related to cable and telecommunication investments. Net
gains from the sales of investments in fiscal 2001 included a gain from our
investment in Titus Communications (which was merged with Jupiter
Telecommunications) and the closing of the sale of Transpoint to CheckFree
Holdings Corp. Interest and dividend income increased $591 million from fiscal
2000, reflecting a larger investment portfolio.
Income Taxes
Our effective tax rate for fiscal
2003 was 32%, reflecting a one-time benefit in the second quarter of $126
million from the reversal of previously accrued taxes. The tax reversal stems
from a 9th Circuit Court of Appeals ruling in December 2002 overturning a
previous Tax Court ruling that had denied tax benefits on certain revenue
earned from the distribution of software to foreign customers. Excluding this
reversal, the effective tax rate would have been 33%. The effective tax rate
for fiscal 2001 and fiscal 2002 was 33% and 32%, respectively.
ACCOUNTING CHANGES
Effective July 1, 2001, we adopted 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 (on a pre-tax basis)
was $311 million in fiscal 2001.
Effective July 1, 2000, we 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. The adoption of SFAS 133 resulted in a cumulative pre-tax
reduction to income of $560 million ($375 million after-tax) and a cumulative
pre-tax reduction to other comprehensive income (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.
STOCK-BASED COMPENSATION
On July 8, 2003, we announced changes in employee
compensation designed to help us continue to attract and retain the best
employees, and to better align employee interests with those of our
shareholders. Employees will be granted Stock Awards instead of stock options.
The Stock Award program offers employees the opportunity to earn actual shares
of our stock over time, rather than options that give employees the right to
purchase stock at a set price. As part of the changes, we announced that a
significant portion of stock-based compensation for more than 600 of our senior
leaders will depend on growth in the number and satisfaction of our customers.
We also indicated that we are working on a plan to enable employees to realize
some value on the portion of their stock options that are currently
out-of-the-money, by selling their options to a third-party financial
institution. If approved, we expect to implement this plan by the end of 2003.
In addition to announcing changes to
our employee compensation arrangements, we also indicated that we will adopt
the fair value recognition provisions of SFAS 123, Accounting for
Stock-Based Compensation, effective July 1, 2003, and will report that change
in accounting principle using the retroactive restatement method described in
SFAS 148, Accounting for Stock-Based Compensation-Transition and Disclosure.
Note 16 of the Notes to the Financial Statements provides pro forma income
statements for 2001, 2002, and 2003 as if compensation cost for our stock
option and employee stock purchase plans had been determined as prescribed by
SFAS 123.
FINANCIAL CONDITION
Our cash and short-term investment
portfolio totaled $49.05 billion at June 30, 2003, an increase of $10.40 billion from
fiscal year 2002. The portfolio consists primarily of fixed-income securities,
diversified among industries and individual issuers. Our 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 order to diversify financial risk. The portfolio is primarily
invested in short-term securities to minimize interest rate risk and facilitate
rapid deployment for immediate cash needs.
Unearned revenue as of June 30, 2003
was $9.02 billion, increasing $1.27 billion from June 30, 2002, reflecting the
addition of new and anniversary multi-year licensing agreements, partially
offset by continued recognition of unearned revenue from multi-year licensing
in prior periods.
Cash flow from operations was $15.80
billion for fiscal 2003, an increase of $1.29 billion from fiscal 2002. The
increase reflects a $2.16 billion increase in net income from fiscal year 2002
and an increase of $1.37 billion in unearned revenue, offset by an increase of
$2.36 billion in recognition of unearned revenue. Cash used for financing was
$5.22 billion in fiscal 2003, an increase of $651 million from the prior year.
The increase reflects a cash dividend payment of $857 million in 2003 and an
increase of $417 million in common stock repurchase, offsetting $623
million received for common stock issued. We repurchased 238.2 million shares
of common stock under our share repurchase program in fiscal 2003. Cash used
for investing was $7.21 billion in fiscal 2003, a decrease of $3.63 billion
from fiscal 2002, due to stronger portfolio performance on sold and matured
investments.
Cash flow from operations was $14.51
billion for fiscal 2002, an increase of $1.09 billion from fiscal 2001. The
increase reflected strong growth in unearned revenue as a result of the
significant number of customers that purchased Upgrade Advantage during the
Licensing 6.0 transition period. This resulted in an increase in billings and a
corresponding increase in the unearned revenue amount. Cash used for financing
was $4.57 billion in fiscal 2002, a decrease of $1.01 billion from the prior
year. The decrease reflected the repurchase of put warrants in the prior year.
We repurchased 245.6 million shares of common stock under our share repurchase
program in fiscal 2002. In addition, 10.2 million shares of common stock were
acquired in fiscal 2002 under a structured stock repurchase transaction. We
entered into the structured stock repurchase transaction in fiscal 2001, which
gave us the right to acquire 10.2 million of our shares in exchange for an
up-front net payment of $264 million. Cash used for investing was
$10.85 billion in fiscal 2002, an increase of $2.11 billion from fiscal
2001.
Cash flow from operations was $13.42
billion in fiscal 2001, an increase of $2.00 billion from the prior year. The
increase was primarily attributable to the growth in revenue and other changes
in working capital, partially offset by a decrease in the stock option income
tax benefit, reflecting decreased stock option exercises by employees. Cash
used for financing was $5.59 billion in fiscal 2001, an increase of $3.39
billion from the prior year. The increase primarily reflected the repurchase of
put warrants in fiscal 2001, compared to the sale of put warrants in the prior
fiscal year, as well as an increase in common stock repurchased. All
outstanding put warrants were either retired or exercised during fiscal 2001.
During fiscal 2001, we repurchased 178.1 million shares. Cash used for
investing was $8.73 billion in fiscal 2001, a decrease of $658 million from the
prior year.
We have no material long-term debt.
Stockholders' equity at June 30, 2003 was $61.02 billion. We will continue
to invest in sales, marketing, product support infrastructure, and existing and
advanced areas of 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 $117 million on June 30, 2003. We have not engaged in any related
party transactions or arrangements with unconsolidated entities or other
persons that are reasonably likely to materially affect liquidity or the
availability of or requirements for capital resources.
We believe existing cash and
short-term investments together with funds generated from operations should be
sufficient to meet operating requirements. Our philosophy regarding the maintenance
of a balance sheet with a large component of cash and short-term investments,
as well as equity and other investments, reflects our views on potential future
capital requirements relating to research and development, creation and
expansion of sales distribution channels, investments and acquisitions, share
dilution management, legal risks, and challenges to our business model. We
continuously assess our investment management approach in view of our current
and potential future needs.
Off-balance sheet arrangements
We have operating leases for most U.S. and international sales and support
offices and certain equipment. Rental expense for operating leases was $281
million, $318 million, and $290 million in 2001, 2002, and 2003, respectively.
Future minimum rental commitments under noncancellable leases, in millions of
dollars, are: 2004, $218; 2005, $202; 2006, $172; 2007, $134; 2008, $116; and
thereafter, $429.
We have unconditionally guaranteed
the repayment of certain Japanese yen denominated bank loans and related
interest and fees of Jupiter Telecommunication, Ltd., a Japanese cable company
(Jupiter). These guarantees arose on February 1, 2003 in conjunction with the expiration
of prior financing arrangements, including previous guarantees by us. The
financing arrangements were entered into by Jupiter as part of financing its
operations. As part of Jupiter's new financing agreement, we agreed to
guarantee repayment by Jupiter of the loans of approximately $51 million. The
estimated fair value and the carrying value of the guarantees was $10.5 million
and did not result in a charge to operations. The guarantees are in effect
until the earlier of repayment of the loans, including accrued interest and
fees, or February 1, 2009. The maximum amount of the
guarantees is limited to the sum of the total due and unpaid principal amounts,
accrued and unpaid interest, and any other related expenses. Additionally, the
maximum amount of the guarantees, denominated in Japanese yen, will vary based
on fluctuations in foreign exchange rates. If we were required to make payments
under the guarantees, we may recover all or a portion of those payments upon
liquidation of Jupiter's assets. The proceeds from such liquidation cannot be
accurately estimated due to the multitude of factors that would affect the
valuation and realization of the proceeds in the event of liquidation.
In connection with various operating
leases, we issued residual value guarantees, which provide that if we do not
purchase the leased property from the lessor at the end of the lease term, then
we are liable to the lessor for an amount equal to the shortage (if any)
between the proceeds from the sale of the property and an agreed value. As of June
30, 2003,
the maximum amount of the residual value guarantees was approximately $271
million. We believe that proceeds from the sale of properties under operating
leases would exceed the payment obligation and therefore no liability to us
currently exists.
We provide indemnifications of
varying scope and size to certain customers against claims of intellectual
property infringement made by third parties arising from the use of our
products. We evaluate estimated losses for such indemnifications under SFAS 5, Accounting
for Contingencies, as interpreted by FIN 45. We consider such factors as
the degree of probability of an unfavorable outcome and the ability to make a
reasonable estimate of the amount of loss. To date, we have not encountered
material costs as a result of such obligations and have not accrued any
liabilities related to such indemnifications in our financial statements.
RECENTLY ISSUED ACCOUNTING STANDARDS
In January 2003, the FASB issued
Interpretation 46, Consolidation of Variable Interest Entities. In
general, a variable interest entity is a corporation, partnership, trust, or
any other legal structure used for business purposes that either (a) does not
have equity investors with voting rights or (b) has equity investors that do
not provide sufficient financial resources for the entity to support its
activities. Interpretation 46 requires a variable interest entity to be
consolidated by a company if that company is subject to a majority of the risk
of loss from the variable interest entity's activities or entitled to receive a
majority of the entity's residual returns or both. The consolidation
requirements of Interpretation 46 apply immediately to variable interest
entities created after January 31, 2003. The consolidation requirements
apply to transactions entered into prior to February 1, 2003 in the first fiscal year or interim
period beginning after June 15, 2003. Certain of the disclosure
requirements apply in all financial statements issued after January
31, 2003,
regardless of when the variable interest entity was established. The adoption
of the Interpretation on July 1, 2003 did not have a material impact on
our financial statements.
In April 2003, the FASB issued SFAS
149, Amendment of Statement 133 on Derivative Instruments and Hedging
Activities, which amends and clarifies accounting for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities under SFAS 133. The Statement is
effective (with certain exceptions) for contracts entered into or modified
after June 30, 2003. We do not believe the adoption of
this Statement will have a material impact on our financial statements.
In May 2003, the FASB issued SFAS
150, Accounting for Certain Financial Instruments with Characteristics of
both Liabilities and Equity. The Statement establishes standards for how an
issuer classifies and measures certain financial instruments with characteristics of both liabilities
and equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). It is
effective for financial instruments entered into or modified after May
31, 2003,
and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. While we do not believe the
adoption of this Statement will have a material impact on our financial
statements, we continue to assess the impact this Statement will have on
certain of our share repurchase programs.
APPLICATION OF CRITICAL ACCOUNTING
POLICIES
Our financial statements and
accompanying notes are prepared in accordance with U.S. GAAP. Preparing
financial statements requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenue, and expenses.
These estimates and assumptions are affected by management's application of
accounting policies. Critical accounting policies for us include revenue
recognition, impairment of investment securities, impairment of goodwill,
accounting for research and development costs, accounting for legal
contingencies, and accounting for income taxes.
We account for the licensi
