Speech Transcript – Bob Herbold, Share Holders 97 Meeting

MR. Herbold: Good morning.Thanks for getting up early this morning.I want to call the meeting to order.I’m Bob Herbold, Executive Vice President and Chief Operating Officer.First let me begin with a few introductions.Over to my left and your right is first Bill Gates, our Chief Executive Officer and Chairman of the Board.Next to Bill is Steve Ballmer, Executive Vice President of Sales and Support.Bill Neukom, Senior Vice President of Law and Corporate Affairs.And Greg Maffei, Vice President and Chief Financial Officer.(Mr. Herbold then introduced several other people, including members of Microsoft’s Board of Directors, and Bill Neukom reported on the notice of the meeting and the fact that proxies representing 90 percent of the approximately 1.2 billion shares outstanding had been received.)

What I’d like to do here first is review the overall performance of the company.We’ll first take a look at last fiscal year and then take a brief look at the first quarter that has just been completed.As far as the overall FY 97 results, it was our 22 nd consecutive year of record revenue and profit.The fiscal year 97 revenue was $11.4 billion, and that’s up 31 percent versus year ago.It gets better.This is a particularly noteworthy result, because FY 96 was actually a great year for us where our revenue was up 46 percent due to Windows 95.Now if you looked over the last five years, the revenue has been growing at a compounded rate of 32 percent, which is a terrific result.Our net income increased from $2.2 billion to $3.5 billion, which is up 57 percent.That strong net income growth of 57 percent versus the 31 percent revenue growth is due to the operating expenses only being up 17 percent.We’ll talk a little bit more about that in a moment.

We’re trying to operate very efficiently.In regard to operating costs and the savings, we’re plowing them into R & D and we’re plowing them into profit, obviously.All the channels and product divisions grew at a healthy rate.Now let me say a few words about the individual product groups for a moment.The platform revenue grew 45 percent up to $6 billion dollars.This was fueled by continued strong performance of our Windows 95 platform and the Windows NT Server operating system.Applications and content grew 18 percent to $5.4 billion in revenue.That’s up 27 percent versus last fiscal year.Now the slower growth rate here is due to the expected impact of saturation of desktop applications, the continued shift toward licensing from packaged product, and the fact that we rate the revenue and had unearned revenue associated with our Office 97 product.As far as the channels, OEM grew 39 percent to $3.5 billion, reflecting strong PC shipments and continued adoption of the Windows 95 32-bit operating system.Corporate licensing continues to be very important to us.If you look at licensing, which includes things like Select and volume license pack subscriptions, they represented 65 percent of our finished good units at the end of fiscal 97, and that’s contrasted to 57 percent at the end of fiscal 1996.Corporate licensing represents a higher percentage of finished goods in North America, namely 72 percent versus 63 percent in Europe, 45 percent in the Far East, and 62 percent in other international areas.

Let me talk a moment about cost of goods sold.The increased licensing activity that I just mentioned, as well as OEM revenue, the continued shift from disks to CD-ROMs, the higher revenue that’s associated with our BackOffice server products, and also production efficiencies have led to reduced cost of good sold, achieving 9.6 percent of net revenue versus 13.7 a year ago.That’s a terrific result.We’re very fortunate to have those kind of trends working in our favor.It would be brutal to have them going the other way.In fact, if you looked at the cost of producing products for our company this fiscal year that we just completed, that total cost in dollars was actually nine percent less than the cost last year, even though our revenue was up 31 percent.And that’s a fine result.

Now at the end of fiscal year 96, 65 percent of our full packaged product was CD-ROM product.And this moved up to 89 percent being CD-ROM product at the end of fiscal year 97.Now for perspective, if you take a box of Windows 95, it requires 26 floppy disks, but the CD-ROM version of that product requires only one CD-ROM diskette.And so the significant difference in the amount of work in putting that together is what drives a lot of that efficiency.Cost of goods sold was down to 7.6 percent in Q4 of FY 97, which is a remarkably low figure that certainly reflects these dynamic trends that I just mentioned.

Now let’s look at expenses in total.R & D expenses grew slightly faster than revenue, up 34 percent versus the revenue, which was up 31 percent.We think that’s a very wise thing to do.It’s a great investment and we intend to continue to increase our investments in R & D.Now as I mentioned earlier, the operating expenses was very well behaved.Sales and marketing expenses grew only 7 percent, and G & A expenses only 15 percent.And that’s why, when you combine them with our R & D activity, you only get the 17 percent that I mentioned before versus the 31 percent on total revenue.

Now in terms of profit performance, what happens when you have those expenses growing at a much slower rate?You get a profit margin after tax that increases significantly.And we’re up to 30.4 percent in FY 97, and that’s up from 25.3 percent in FY 96.So our continued focus on running efficiently and then investing some of those savings in R & D, investing in some of that in profit worked out well in fiscal year 97 and we’ll try and do it again this fiscal year.

As far as headcount goes, full time employee enrollment grew from 20,561 people in June of 1996 to 22,232 in June of ’97.Growth in headcount would have been higher, actually, had it not been for the sale of our Canyon Park facility where we separated about 500 employees, most of whom went and became employees of Kao Information Systems, which bought the facility in Canyon Park.We also completed other outsourcing during the year that decreased full time headcount roughly 200.Our greater Redmond headcount stood at 12,098 people on June 30, 1997, the end of our fiscal year, and that represents 54 percent of our total headcount for the entire company.So clearly, the center of gravity is still here in the Puget Sound area.

As far as the balance sheet, our total cash equaled $9 billion at the end of the fiscal year, an increase of $2.1 billion versus year ago.We have no long-term debt and we’re positioned to make the necessary investments that we have to make to keep this company vital.

Let me talk about stock buy-back for a moment.The purpose of our stock buy-back program is to provide shares for stock options.We purchased 37 million shares in FY 97 for a cost of $3.1 billion, so on average we bought at a price of $83.75.Life to date, we have purchased 162 million shares at a cost of $7.2 billion for an average cost of $44.63.Now the value of those 162 million shares that we purchased is about $21 billion, so we feel good about our investment of $7.2 billion.Our buy-back program is enhanced by selling put warrants on a regular basis.

Now enough on fiscal year 97.Let’s talk about this fiscal year and the first quarter and how we’re doing.Revenues were $3.1 billion, up 36 percent versus year ago.Our applications and content business registered a revenue of $1.43 billion, which is up 29 percent versus a year ago.Desktop applications revenue was strong due to the continued strength of Office 97.Our Interactive Media Group had a great quarter as they begin the sell-in for the holiday season.By the way, watch out for Microsoft Barney.We think it’s going to be a very hot product during the holiday season.

Platform growth revenue was $1.7, up 43 percent versus year ago.NT Server continued to gain market share on Intel-based servers, and we’re up to almost 50 percent share in that context.Exchange revenue was up nearly three times over the prior year due to strong sales of Exchange 5.0.Windows 95 had a record quarter with sequential increases in both OEM and the retail channel.Concerning OEM channel, NT Workstation units grew sequentially from 6 percent of total Windows 95 and Windows NT Workstation units up to 9 percent, which is a great trend.

As far as the availability of financial information and all the facts and figures that I’ve just covered, naturally we’re required to publish hard copy annual reports and we would encourage you, on the other hand, to go to the online version of this information.In fact, there’s a PC set up outside there, and people can assist you in taking a try at doing just that if you have never done it before.The shareholder section of microsoft.com contains a multitude of financial and other kinds of information about your company.Microsoft.com is the gateway to tons of information about this organization, and I would really encourage you to get familiar with that Web site.

Now let’s look forward to the remainder of fiscal year 97.This is one of the most competitive environments that we have ever faced.We do not have a major product introduction during the remainder of this fiscal year.R & D should continue to grow faster than revenues as we invest in the future.We’re making important investments in the sales area.We’re going to be going against very strong third and fourth quarters from last year as we head into the second half of this fiscal year.And people should be appropriately cautious about their estimates of our business performance, given all those watch-outs.On the other hand, the longer-term view is what we really all need to take.Our stock price is up significantly versus a year ago when we met.That won’t always be the case.We urge you all to take a long-term perspective with respect to Microsoft shares.We’re investing for the long term and we want you to do exactly that.We appreciate your long-term confidence and work hard to deserve it.

I do want to end, though, here, with a couple of reminders in regard to the risks in this business, because it is risky.We have serious competition in every category of our business, and we’re very dependent on continual growth of PC shipments.The role of the server threatens the role of the operating system on the client, and the role of thin clients and the design of applications may completely redefine how applications are put together.We face continuing pricing pressure in virtually all of the segments of our business, and saturation of desktop applications in the corporate world is a reality.While we make small progress in the area of piracy, it is still a huge issue on a global basis.Last, but not least, litigation must be viewed as a serious business risk.

Well that concludes the business review, and what I’d like to do at this juncture is introduce Bill Gates for his perspective on the business and on the future.Thank you very much.