2,795,000 Shares

Microsoft Corporation
Common Stock_____________________Of the 2,795,000 shares of Common Stock offered hereby, 2,000,000 shares are being soldby the Company and 795,000 shares are being sold by the Selling Stockholders. See “Principal
and Selling Stockholders.” The Company will not receive any of the proceeds from the sale ofshares by the Selling Stockholders.
Prior to this offering, there has been no public market for the Common Stock of theCompany. For the factors which were considered in determining the initial public offering price,see “Underwriting.”
See “Certain Factors” for a discussion of certain factors which should be considered byprospective purchasers of the Common Stock offered hereby.
_____________________
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION NOR HAS THE COMMISSIONPASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
_____________________
Initial Public
Offering Price

Underwriting
Discount (1)Proceeds toCompany (2)Proceeds to
Selling
Stockholders (2)Per Share................................................... $21.00
Total (3).................................................... $58,695,000$1.31$3,661,450$19.69$39,380,000$19.69$15,653,550

————
(1)
The Company and the Selling Stockholders have agreed to indemnify the Underwriters
against certain liabilities, including liabilities under the Securities Act of 1933.
(2) Before deducting expenses of the offering estimated at $541,000, of which $452,000 will be
paid by the Company and $89,000 by the Selling Stockholders.
(3) The Company has granted to the Underwriters an option to purchase up to an additional
300,000 shares at the initial public offering price, less the underwriting discount, solely tocover over-allotments. If such option is exercised in full, the total Initial Public Offering
Price, Underwriting Discount and Proceeds to Company will be $64,995,000, $4,054,450 and$45,287,000, respectively.
_____________________The shares are offered severally by the Underwriters, as specified herein, subject to receipt
and acceptance by them and subject to their right to reject any order in whole or in part. It is
expected that the certificates for the shares will be ready for delivery at the offices of Goldman,
Sachs & Co., New York, New York on or about March 20, 1986.

Goldman, Sachs & Co.

Alex. Brown & Sons_____________________The date of this Prospectus is March 13, 1986.

Incorporated

Milestonesin Microsoft History.
March 1983 Microsoft forms Microsoft
Press to publish and market computeroriented books.

January 1975 Microsoft develops aBASIC Interpreter for the first commerciallyavailable personal computer, the MITS
Altair. Over the next four years Microsoft
licenses the BASIC Interpreter to Apple
Computer, Commodore International, andTandy Corporation; and introduces theMicrosoft® FORTRAN and Microsoft®
COBOL Compilers and the Microsoft®
Macro Assembler.

July 1983 Microsoft introduces theMicrosoft® Mouse, a hand-held pointing
and editing device.
October 1983 A graphics-based word
processor, Microsoft® Word, is added
to the applications product line. Three
additional
MS-DOS business applications are
released over the next two years:
Microsoft® Chart, Microsoft® Projectand Microsoft® Access.

October 1978 Microsoft retains ASCII
Corporation as its sales representative inJapan for the Far Eastern Market.
February 1980 Microsoft introduces
Microsoft® XENIX®, a UNIX®-based
operating system for 16-bit multi-user
computer systems.

January 1984 Microsoft releases
versionsof the Microsoft BASIC Interpreter andMicrosoft Multiplan simultaneously withApple’s introduction of the Apple®
Macintosh™. Macintosh versions ofMicrosoft Word, Microsoft Chart, andMicrosoft® File for the Apple Macintosh
follow within a year.

August 1980 Microsoft begins
development of systems and language
software for the IBM® Personal Computer.
Microsoft releases the Microsoft®
SoftCard® system, a software/hardwareenhancement
product that adds the CP/M® operating
systemto the Apple® II.

August 1984 IBM introduces anadvanced version of the Personal
Computer called the IBM PC AT.
Systems software offered on the PC
AT includes MS-DOS, Microsoft®
Networks, and Microsoft XENIX.

August 1981 IBM introduces the IBM
Personal Computer, which offers theMicrosoft® MS-DOS® operating systemand the Microsoft BASIC Interpreter. At thesame time, Microsoft introduces otherlanguage products for the IBM PC.

October 1985 Microsoft begins
shipping Microsoft® Excel, aspreadsheet integrated
with business graphics and database
modules, for the Apple Macintosh.

April 1982 Microsoft expands sales
operations to the European market andoffers localized products.

November 1985 Microsoft begins
shipping Microsoft® Windows, agraphical operating environment thatruns on the Microsoft
MS-DOS operating system.

August 1982 Microsoft introduces its first
application software program, theMicrosoft® Multiplan® electronic
worksheet.

The Company intends to furnish its stockholders with annual reports containing
audited financial statements certified by an independent public accounting firm andquarterly reports for the first three quarters of each fiscal year containing unaudited
interim financial information.
2

IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVERALLOT OR EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE
MARKET PRICE OF THE COMMON STOCK OF THE COMPANY AT A LEVELABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET.
SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.

3

PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed information andConsolidated Financial Statements appearing elsewhere in this Prospectus. All information relating
to the Company's Common Stock contained in this Prospectus, except as presented in theConsolidated Financial Statements, reflects the conversion of all outstanding shares of Preferred
Stock into Common Stock on the date of this Prospectus.
The Company
Microsoft designs, develops, markets, and supports a product line of systems and applications
microcomputer software for business and professional use. The Microsoft Software Product Linechart inside the front cover of this Prospectus illustrates the evolution anddiversity of the Company's
product line. Microsoft’s systems software products include Microsoft® MS-DOS®, a 16-bit
microcomputer operating system used on the IBM PC and IBM compatible computers, and computer
language products in six computer languages. The Company offers business applications software
products in the following categories: word processing, spreadsheet, file management, graphics,
communications, and project management. The Company's products are available for 8-bit, 16-bit,
and 32-bit microcomputers, including IBM, Tandy, Apple, COMPAQ, Olivetti, AT&T, Zenith,
Wang, Hewlett-Packard, DEC, Siemens, Philips, Mitsubishi, and NEC. Microsoft develops most of
its software products internally using proprietary development tools and methodology. The Company
markets and distributes its products domestically and internationally through the original equipment
manufacturer (“OEM”) channel and through the retail channel primarily by means of independent
distributors and dealers and by direct marketing to corporate, governmental, and educationalcustomers.
The Offering
Common Stock offered by the Company .......... 2,000,000 shares (1)Common Stock offered by the Selling Stockholders
795,000 shares
Common Stock to be outstanding after the offering
24,715,113 shares (1)Proposed NASDAQ symbol.............................. MSFT
Use of Proceeds ................................................. For general corporate purposes, principally working
capital, product development, and capital
expenditures.
Selected Consolidated Financial Information(In thousands, except per share data)
Year Ended June 30,
1983
1984

1982

Six Months Ended
December 31,
1984
1985
(Unaudited)

1985

Income Statement Data:
Net revenues …………………………...... $ 24,486 $ 50,065 $ 97,479 $140,417 $ 62,837 $ 85,050
Income before income taxes…….…….....
5,595
11,06428,03042,843
18,21929,048Net income…………………………….....
3,507
6,487
15,88024,101
9,996
17,118Net income per share……………….…..... $
.17 $
.29 $
.69 $
1.04 $.43 $.72
Shares used in computing
net income per share……….…….….... 21,240
22,681
22,94723,26023,25323,936
ActualBalance Sheet Data:
Working capital……………….……………….………………..……..……
Total assets……………….……………….……………….…….…….……
Total long-term debt ………..……………….……………………………...
Stockholders' equity……………….……………….………….….…….…..

4

December 31, 1985
As Adjusted (1) (2)(Unaudited)$57,574
94,438—71,845$ 96,502
133,366—
110,773

THE COMPANY
Microsoft designs, develops, markets, and supports a product line of systems and applications
microcomputer software for business and professional use. The Microsoft Software Product Line chart
inside the front cover of this Prospectus illustrates the evolution and diversity of the Company’s productline. Microsoft markets over 40 software products, including three operating systems, computer language
products in six computer languages, and business applications products in six categories: word
processing, spreadsheet, file management, graphics, communications, and project management. The
Company’s products are available on 8-bit, 16-bit, and 32-bit microcomputers, including IBM, Tandy,
Apple, COMPAQ, Olivetti, AT&T, Zenith, Wang, Hewlett-Packard, DEC, Siemens, Philips, Mitsubishi,
and NEC. Microsoft develops most of its software products internally using proprietary development
tools and methodology.
Microsoft® MS-DOS®, introduced in 1981 as a 16-bit operating system for Intel microprocessor
architectures, is running on approximately four million IBM PC and IBM compatible microcomputers,
according to industry publications. Microsoft® XENIX®, a UNIX®-based multi-user operating system for
microcomputers, is designed to accommodate transaction oriented data processing tasks. The Company’s
most widely used language product, Microsoft® BASIC Interpreter, is running on an estimated eight
million microcomputers, according to industry publications. The Company markets compiler products inthe following computer languages: BASIC, “C”, FORTRAN, COBOL, and Pascal, and machine language
assembler products. Microsoft® Word, a word processing product, Microsoft® Multiplan®, an electronic
spreadsheet, and Microsoft® Chart, a graphics program, are business applications products which run on
Microsoft MS-DOS-based computers and on the Apple Macintosh™. Microsoft® Excel, an integrated
spreadsheet, and Microsoft® File, a file management product, run on the Apple Macintosh. Microsoft®
Access, a communications product, and Microsoft® Project, a project management tool, are MS-DOS
applications.
Microsoft markets and distributes its software products domestically and internationally throughboth the OEM and retail channels. In the OEM channel, Microsoft generally provides an OEM withmaster copies of the software and documentation which the OEM duplicates, packages, and distributes,
although there is increasing OEM marketing of Microsoft’s packaged language and application products.
Domestic retail marketing involves the distribution of Microsoft’s packaged software products primarily
through independent distributors, large volume dealers, corporate key dealers, and other dealers, anddirect marketing to corporate customers, government agencies, and colleges and universities. International
OEM and retail marketing and distribution of domestic and foreign language versions of Microsoft’s
systems and applications software products are conducted through seven foreign subsidiaries and several
independent sales representatives.
The Company was founded as a partnership in 1975 and was incorporated in the state of Washington
on June 25, 1981. The principal executive offices of Microsoft are located at 16011 NE 36th Street,
Redmond, Washington 98073-9717, and its telephone number is (206) 882-8080. Unless the context
otherwise requires, the terms “Microsoft” and the “Company” are used herein to refer to Microsoft
Corporation and its subsidiaries.

5

CERTAIN FACTORSThe following factors should be carefully considered in evaluating the Company and its businessbefore purchasing the shares offered hereby.
Market Acceptance of Microsoft MS-DOS Operating System. The Company believes Microsoft
MS-DOS is the most widely used operating system for the IBM PC and IBM compatible microcomputers.
If another developer were to produce and successfully market an operating system that competes against
MS-DOS, the Company could lose substantial revenues. In addition, since IBM has been the leader insales of microcomputers since its introduction of the IBM PC in 1981, a decision by IBM not to offer
MS-DOS or to indicate a preference for another operating system on its current or future microcomputers
would have an adverse impact on the Company’s revenues. Finally, the Company’s reputation in the
microcomputer industry is partially based on its position as a major supplier of systems software to many
microcomputer OEMs, and if MS-DOS were to lose its position as the most widely used operating system
for the IBM PC and IBM compatibles it could adversely affect the Company’s relationships with its
customers.
Reliance on Key Officer. William H. Gates III, a founder of Microsoft and its chairman and chief
executive officer, plays an important role in the technical development and management efforts of theCompany. Mr. Gates participates actively in significant operating decisions, leads deliberations
concerning strategic decisions, and meets with OEM customers. Mr. Gates also has overall supervisory
responsibility for the Company’s research and development work. The loss of his services could have amaterial adverse effect on the Company’s position in the microcomputer software industry and on its new
product development efforts. There is no employment agreement between Mr. Gates and the Company.
Price Competition. To date price competition has not been a major factor in the microcomputer
software market. It seems likely to management, however, that price competition, with its attendant
reduced profit margins, will emerge in the next few years as a significant consideration. The recent
increase of “site licenses” (permitting copying of the program and documentation) and discount pricing
for large volume retail customers is evidence of such competition.
Change in Marketing Structure in Japan. The Company’s exclusive sales representative agreementwith its Japanese agent terminates on or before March 17, 1986. A wholly-owned subsidiary, Microsoft
K.K., was formed by the Company in Japan in February 1986 to handle OEM and retail business. The
transition could adversely affect net revenues in Japan. In fiscal 1985, customers in Japan accounted forapproximately 12% of the Company’s net revenues. See “Business—Marketing and Distribution—
International OEM Distribution.”
Tax Considerations. In the course of a current examination of the years ended June 30, 1983 and1984 by the Internal Revenue Service, a field agent has proposed that Microsoft is subject to the personal
holding company (“PHC”) tax. The PHC tax is 50% of after-tax income and through December 31, 1985
could be as much as approximately $30,000,000 plus interest. At its option, a corporation subject to the
PHC tax may declare a “deficiency dividend” to its stockholders of record at the time such a dividend isdeclared in an amount equal to the corporation’s undistributed PHC income. For Microsoft this could be
as much as approximately $60,000,000 as of December 31, 1985. The payment of a deficiency dividend
avoids a PHC tax to the corporation but is taxable to the stockholders. If a PHC tax were to be assessed
and the Company elected to pay the tax, the payment of tax would be recorded as a charge to operations
and would reduce net income accordingly. If a PHC tax were to be assessed and the Company elected todeclare a deficiency dividend, retained earnings would be reduced by the amount of such a dividend.
Although management and counsel presently believe there is a small risk that the Company might have toeither pay a PHC tax or declare a deficiency dividend, they believe that it is more likely than not thatneither a material payment of a PHC tax nor a material deficiency dividend will be required. Because thetotal amount of any PHC tax that might be assessed could vary significantly based upon the specific year
for which such an assessment might occur and other facts and circumstances and because management
and counsel presently believe that it is more likely than not that neither a material payment of a PHC tax
nor a material deficiency dividend will be required, management has not formulated specific intentions as
to how the Company will proceed in the event such a tax is assessed. For additional information see Note
4 of Notes to Consolidated Financial Statements.
6

A corporation not subject to the PHC tax may be subject to the accumulated earnings tax (“AET”), a
penalty tax assessed against corporations that avoid income tax at the stockholder level by unnecessarily
accumulating funds in the corporation rather than paying dividends. The tax, at approximately 38.5%, isassessed on excess income after adjustments for regular corporate taxes and the reservation of funds
reasonably required for normal business operations. Although Microsoft has and expects to continue tohave significant retained earnings, management believes the accumulated funds together with theproceeds of this offering are necessary for working capital, product development, capital expenditures andpotential acquisitions, and that the AET will not be applicable. However, the AET involves subjective
questions and there is some risk that the Company might be subject to the AET in the future.
Shares Eligible for Future Sale. Approximately 230,000 shares of Common Stock held by current
stockholders are eligible for sale in the open market without restriction and approximately 21,766,000
additional shares will be eligible for sale under Rule 144 under the Securities Act of 1933 beginning 90
days after the date of this Prospectus. Of these 21,766,000 shares, approximately 21,070,000 shares are
subject to an agreement with the Underwriters which restricts their sale without the prior written approvalof the Underwriters for 120 days after the date of this Prospectus. Prior to the end of this 120 day period,
the Company also intends to register approximately 2,900,000 shares of Common Stock issuable under its
1981 Stock Option Plan and 300,000 shares of Common Stock issuable under its 1986 Employee Stock
Purchase Plan. Sales of substantial amounts of Common Stock in the public market could adversely affectthe market price of Common Stock. See “Shares Eligible for Future Sale.”Absence of Previous Trading Market. Prior to this offering there has been no public market for the
Common Stock. Consequently the initial public offering price has been determined by negotiations
among the Company, the Selling Stockholders, and the Representatives of the Underwriters. See“Underwriting” for factors considered in determining the initial public offering price.
USE OF PROCEEDSThe net proceeds to be received by the Company from the sale of the Common Stock offered by theCompany are estimated to be $38,928,000 ($44,835,000 if the Underwriters’ over-allotment option is
exercised in full). The net proceeds are expected to be used for general corporate purposes, principally
working capital, product development, and capital expenditures. The Company presently has no specificplans for any significant portion of the proceeds. Proceeds may also be used to acquire companies,
products, or expertise which complement the business of Microsoft. No such transactions are being
planned or actively negotiated as of the date of this Prospectus. Pending such uses, the proceeds will be
invested in marketable securities. The Company will not receive any of the proceeds from the sale of theshares of Common Stock being sold by the Selling Stockholders. See “Principal and Selling
Stockholders.”
DIVIDEND POLICYThe Company has never paid cash dividends on its Common Stock. The Company presently intends
to retain earnings for use in its business and therefore does not anticipate paying any cash dividends in theforeseeable future. Payment of any cash dividends will be dependent upon the earnings and financial
condition of the Company, tax considerations discussed under “Certain Factors,” and any other factors
deemed relevant by the Board of Directors.

7

CAPITALIZATION
The following table sets forth the capitalization of the Company as of December 31, 1985, and as
adjusted to reflect the sale of 2,000,000 shares of Common Stock by the Company.
December 31, 1985
ActualAs Adjusted(1 )(Unaudited, in thousands)

Long-term debt………………………………………………………………… $Stockholders’ equity:
Common stock — $.001 par value, 60,000,000 shares authorized,
22,715,113 shares outstanding, 24,715,113 shares outstanding as
adjusted (2) (3) ...…………….………….………….………….…….…..

—

$

—

23

25

Paid-in capital………………………………………………………….……. 5,281
Retained earnings……………………………………………...………….… 67,092

44,20767,092

Translation adjustment………………………………………………...….…

(551)

(551)

Total stockholders’ equity……………………………………………. 71,845

110,773

Total capitalization…………………………………………………………….. $71,845$110,773–————(1) Assumes the Underwriters’ over-allotment option is not exercised. See “Underwriting.”(2) Assumes conversion of the Company’s outstanding Preferred Stock into 1,000,000 shares ofCommon Stock.
(3) Excludes 2,771,757 shares of Common Stock reserved for issuance under the Company’s 1981
Stock Option Plan (the “Option Plan”), under which options for 2,667,861 shares were outstandingat December 31, 1985, and 300,000 shares of Common Stock reserved for issuance under theCompany’s 1986 Employee Stock Purchase Plan (the “Purchase Plan”). See Note 7 of Notes toConsolidated Financial Statements.

8

DILUTION
The net tangible book value of the Company at December 31, 1985 was $71,210,000, or $3.14 pershare. “Net tangible book value per share” represents the amount of total tangible assets less total
liabilities, divided by the number of shares of Common Stock outstanding, after giving effect to theautomatic conversion of all outstanding Preferred Stock into Common Stock. After giving effect to thesale by the Company of 2,000,000 shares of Common Stock (at the initial public offering price and before
deduction of offering expenses and the Underwriters’ discount), the pro forma net tangible book value of
the Company at December 31, 1985, would have been $113,210,000, or $4.58 per share, representing an
immediate increase in net tangible book value of $1.44 per share to existing stockholders and an
immediate dilution of $16.42 per share to the persons purchasing shares at the initial public offering price(“New Investors”). The following table illustrates the per share dilution in net tangible book value pershare to New Investors:
Price to public………………………………………………………………………..

$21.00

Net tangible book value at December 31, 1985…………………………………. $ 3.14
Increase attributable to New Investors………………………………………...….

1.44

Pro forma net tangible book value……………………………………………..…….

4.58

Dilution to New Investors……………………………………………………….…...

$16.42

The following table summarizes at December 31, 1985 the difference between existing stockholders
and New Investors with respect to the number of shares purchased from the Company, the total
consideration paid to the Company and the average price paid per share (for New Investors, at the initialpublic offering price):
Shares Purchased (1)Number
Percent

Total Consideration
Paid to Company
AmountPercent

AveragePrice
Per Share

Existing stockholders………………... 22,715,113
91.9%$ 6,100,000
12.7%
$ .27
New Investors…………..…………… 2,000,000
8.1
42,000,000
87.3
21.00
Total………………..…………. 24,715,113 100.0%$48,100,000
100.0%—————(1) Sales by the Selling Stockholders in the offering will cause the number of shares held by existing
stockholders to be reduced to 21,920,113 or 88.7% of the total shares of Common Stock to beoutstanding after the offering. See “Principal and Selling Stockholders.”
The above computations assume no exercise of the Underwriters’ over-allotment option or ofoutstanding employee stock options. See “Underwriting” and “Management—1981 Stock Option Plan.”

9SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth below with respect to the Company’s income
statements for the years ended June 30, 1983, 1984, and 1985 and the Company’s balance sheets at June30, 1984 and 1985 are derived from the audited Consolidated Financial Statements included elsewhere inthis Prospectus and should be read in conjunction with those financial statements and footnotes thereto.
The selected income statement data for the year ended June 30, 1982 and the selected balance sheet data
at June 30, 1982 and 1983 are derived from audited consolidated financial statements which are notincluded in this Prospectus. The selected consolidated financial data for the six month periods ended
December 31, 1984 and 1985 are unaudited, but in the opinion of the Company include all adjustments,
consisting of normal recurring adjustments, necessary for a fair presentation thereof. The results for thesix months ended December 31, 1985 are not necessarily indicative of the results to be expected for thefull fiscal year. See “Management’s Discussion and Analysis of Results of Operations and Financial
Condition—Quarterly Results.”(In thousands, except per share amounts)
Six Months Ended
December 31,
Year Ended June 30,
1983
1984
1985
1984
1985
(Unaudited)

1982

Income Statement Data:
Net revenues…………………… $ 24,486
Costs and expenses:
Cost of revenues…………..…
8,647
Research anddevelopment……………..…
3,597
Sales and marketing…………
4,009
General and administrative….
3,037
Total costs and expenses…. 19,290
Income from operations………...
5,196
Non-operating income (loss) .….
399
Income before income taxes……
5,595
Provision for income taxes….….
2,088
Net income……………………... $ 3,507
Net income per share……….….. $.17
Shares used in computing
net income per share………..…
21,240$ 50,065$ 97,479$140,417$ 62,837$ 85,050

15,77322,90030,447

15,507

18,270

7,021
11,916
4,698
39,408

10,66526,027
8,784
68,376

17,10842,512
9,443
99,5107,414
18,2683,831
45,0208,720
24,4296,980
58,39910,657407
11,064
4,577$ 6,487$.29

29,103(1,073)28,03012,150$ 15,880$.69

40,907
1,936
42,84318,742$ 24,101$
1.04

17,817402
18,2198,223$ 9,996$.43

26,651
2,397
29,048
11,930$ 17,118$.72

22,681

22,94723,26023,25323,936

1982

1983

June 30,
1984

1985

December 31,
1985(Unaudited)

Balance Sheet Data:
Working capital…………………….… $ 5,305 $ 9,952$ 21,458$ 41,442$ 57,574
Total assets…………………………… 14,784
24,32847,63765,064
94,438
Total long-term debt…………………..
—
—
705
650
—
Stockholders’ equity…………………..
8,299
14,63930,71254,44071,845————(1) See Note 4 of Notes to Consolidated Financial Statements for information concerning personal
holding company tax.

10

MANAGEMENT’S DISCUSSION AND
ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Results of Operations
The following table sets forth consolidated results of operations as a percentage of net revenues.

Percentage of Net
Revenues For Year
Ended June 30,
1983
1984
1985

Percentage of
Net Revenues
For Six Months
Ended
December 31,
1984
1985

Net revenues………………………………………………………. 100% 100% 100%
Costs and expenses: ……………………………………………….
Cost of revenues……………………………………………….. 32
23
22
Research and development…………………………………….. 14
11
12
Sales and marketing………………………………….…….…... 24
27
30
General and administrative……………….………………….… 997
Total costs and expenses………………………….………... 79
70
71

100%

100%

25
12
29
6
72

22
10
29
8
69

Income from operations……………………………………….….. 21
Non-operating income (loss)..…………………….………………. 1
Income before income taxes………………………………………. 22
Provision for income taxes………………………………………... 9
Net income………………………………………………………... 13%

28
1
29
13
16%

31
3
34
14
20%

30
(1)
29
13
16%

29
1
30
13
17%

The following charts show net revenues by product group for the years ended June 30, 1983, 1984,
and 1985 and by product group and distribution channel for the six months ended December 31, 1984 and
1985.

11

Revenue growth for the years ended June 30, 1984 and 1985 and the six months ended December
31, 1985 resulted from several factors, including the introduction of new products, the expansion of themarket for microcomputer software, and the expansion of the Company’s operations to new geographic
market areas. As the microcomputer software industry and market mature it should not be expected that
the Company’s growth will continue at or approach the rate which occurred from 1983 to the present.
International net revenues for the years ended June 30, 1983, 1984, and 1985 were $10 million,$29.5 million, and $44.7 million and for the six months ended December 31, 1984 and 1985 were $22.1
million and $29.0 million. These amounts represented 20%, 30%, 32%, 35%, and 34% of net revenues forthe respective periods. This growth is primarily the result of the establishment of additional foreignsubsidiaries. Profit margins on international sales are similar to profit margins on domestic sales. For
additional information concerning international sales and operations for the years ended June 30, 1983,
1984 and 1985, see Note 8 of Notes to Consolidated Financial Statements. The recent termination of an
exclusive sales representative in Japan could adversely affect net revenues in Japan. See “Business Marketing and Distribution - International OEM Distribution.”
The reduction in cost of revenues for the years ended June 30, 1984 and 1985 and the six months
ended December 31, 1985 was principally the result of a shift in the sales mix from lower margin
hardware products to higher margin software products and, to a lesser degree, a decrease in the percentageof revenue attributable to Microsoft XENIX which has lower margins. Research and development
expenses have increased, although not as dramatically as net revenues, as a result of planned softwaredevelopment staff increases and expenditures to create development tools. Sales and marketing expenses
as a percentage of net revenues have increased as a result of (i) expanding the Company’s domestic andinternational sales and marketing staff, (ii) the opening of local, regional, and international sales facilities,(iii) higher advertising and related expenditures, and (iv) increases in the provision for doubtful OEM
accounts, primarily in 1985. During 1984 and 1985, and the six months ended December 31, 1985, theCompany’s general and administrative expenses were $8,784,000, $9,443,000, and $6,980,000,
respectively. Such expenses increased as operations expanded.
Non-operating income includes interest income of $407,000, $427,000, and $952,000 for the years
ended June 30, 1983, 1984, and 1985, and $402,000 and $1,151,000 for the six months ended December
31, 1984 and 1985. In addition, in 1984 the Company realized a short term capital loss of $1,500,000
from the write-off of the entire value of a minority interest in a closely held company. In 1985 theCompany realized a short term capital gain of $984,000 upon the sale of marketable equity securities.
During the six months ended December 31, 1985 the Company realized a foreign currency transaction
gain of $1,245,000 resulting from the repayment of debt from certain international subsidiaries.
The effective tax rates for the years ended June 30, 1983, 1984, and 1985 were 41.4%, 43.3%, and43.7%, and for the six months ended December 31, 1984 and 1985 were 45.1% and 41.1%, respectively,of income before income taxes. For an analysis of the differences between the statutory and the effective
income tax rates for the years ended June 30, 1983, 1984, and 1985, see Note 4 of Notes to Consolidated
Financial Statements. The effective tax rate for the six months ended December 31, 1985 was affected byforeign operating profits with no associated income tax expense due to the usage of foreign operating loss
carryforwards.
See Note 4 of Notes to Consolidated Financial Statements for information concerning personal
holding company tax.

12

Quarterly Results
The following table contains selected unaudited consolidated financial results for the six quarters
ended December 31, 1985. In management’s opinion this unaudited information has been prepared on thesame basis as the audited information and includes all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of the information for the periods presented.

September 30,
1984

Net revenues$26,004
Total costs andexpenses …...…… 18,911
Income fromoperations..……… 7,093

Quarter Ended (Unaudited)
December 31,
March 31,
June 30,
September 30,
1984
1985
1985
1985
(In thousands, except per share data)

December 31,
1985$36,833$40,662$36,918$35,153$49,897

26,10825,32329,16825,19033,20910,725

15,339

7,750

9,963

16,688Non-operating
income ..………...

128

273

148

1,387

553

1,844

Income before
income taxes…….

7,221

10,99815,487

9,137

10,516

18,532

Provision forincome taxes….…

3,259

4,964

6,990

3,529

4,346

7,584

Net income…….… $ 3,962
Net income
per share………… $.17$ 6,034$ 8,497$ 5,608$ 6,170$10,948

$

$

$

$

$

Shares used incomputing net
income per share... 23,253.26

23,253.37

23,261.24

23,272.26

23,926.46

23,946

Historically, the Company’s operating results have been influenced by the timing of new productintroductions, holiday season purchases, the signing of license agreements with OEMs, the calendar year
cycle of distributor and dealer contracts, and the mix of revenues between retail and OEM. Operating
results for the quarter ended March 31, 1985 were influenced by the introduction of new products for theApple Macintosh (Microsoft Word, Microsoft File, and Microsoft Business Pack) and the introduction of
Microsoft Word 2.0 for the IBM PC and IBM compatible computers. Operating results for the quarter
ended June 30, 1985 were affected by the mix of revenue which resulted in significant commission
expense, bonuses awarded under the Company’s bonus program, and significant discretionary
expenditures, primarily advertising and contract product development. The quarter ended December 31,
1985 was a record quarter for the Company and included significant revenue from new productintroductions, principally Microsoft Excel for the Apple Macintosh, and from the receipt of orders from
distributors prior to the Company’s reduction of distributor discounts in calendar year 1986. The
Company does not expect results for the quarter ending March 31, 1986 to equal the results for the quarter
ended December 31, 1985.
Liquidity and Capital Resources
Since its inception, the Company has funded its activities almost entirely from funds generated fromoperations. The Company’s cash and short-term investments balance at December 31, 1985 was $38.2
million. The Company believes that the proceeds of this offering, together with existing cash balances andfunds generated from operations, will be sufficient to meet its cash requirements through fiscal 1987.
BUSINESS
13

Microsoft designs, develops, markets, and supports a product line of systems and applications
microcomputer software for business and professional use. The Microsoft Software Product Line chart
inside the front cover of this Prospectus illustrates the evolution and diversity of the Company’s productline. Microsoft markets over 40 software products, including three operating systems, computer language
products in six computer languages, and business applications software in the following categories: word
processing, spreadsheet, file management, graphics, communications, and project management. The
Company’s products are available on 8-bit, 16-bit and 32-bit microcomputers domestically andinternationally, including IBM, Tandy, Apple (Macintosh and Apple II series), COMPAQ, Olivetti,
AT&T, Zenith, Wang, Hewlett-Packard, DEC, Siemens, Philips, Mitsubishi, and NEC.
Microsoft MS-DOS, introduced in 1981 as a 16-bit operating system for Intel microprocessor
architectures, is running on approximately four million IBM PC and IBM compatible microcomputers,
according to industry publications. The Company believes that more of the widely used businessapplications programs run on Microsoft MS-DOS than on any other 16-bit microcomputer operating
system. Microsoft XENIX, a UNIX-based multi-user 16-bit operating system for microcomputers, isdesigned to accommodate transaction oriented data processing tasks. The Company’s first product,
Microsoft BASIC Interpreter, which was introduced in 1975, and newer versions of Microsoft BASIC
Interpreter are running on an estimated eight million microcomputers, according to industry publications.
The Company also markets compiler products in the following computer languages: BASIC, “C”,
FORTRAN, COBOL, and Pascal, and machine language assembler products. Microsoft Word, a word
processing program introduced in 1983, Microsoft Multiplan, an electronic spreadsheet introduced in
1982, and Microsoft Chart, a graphics product introduced in 1984, are business applications products
which run on Microsoft MS-DOS-based computers and on the Apple Macintosh. Microsoft Excel, an
integrated spreadsheet introduced in 1985, and Microsoft File, a file management product also introduced
in 1985, run on the Apple Macintosh. Microsoft Access, a communications tool released in 1985, andMicrosoft Project, a project management product introduced in 1984, are MS-DOS applications.
Microsoft develops most of its software products internally using proprietary development tools andmethodology. As of December 31, 1985 the Company employed 271 persons in software productdevelopment.
Microsoft markets and distributes its software products domestically and internationally throughboth the OEM and retail channels. In the OEM channel Microsoft generally provides an OEM withmaster copies of the software and documentation and the OEM duplicates, packages, and distributes
them, although there is increasing OEM marketing of Microsoft’s packaged language and applications
products. The Company’s domestic OEM sales force of approximately 20 has an active technical andbusiness information relationship with approximately 100 OEM customers. Domestic retail marketing
involves the distribution of Microsoft’s packaged software products primarily through independent
distributors, large volume dealers, corporate key dealers, and other dealers, and direct marketing tocorporate customers, government agencies, and colleges and universities. International OEM and retailmarketing and distribution of domestic and foreign language versions of the Company’s systems softwareand applications software are conducted through seven foreign subsidiaries and several independent sales
representatives. International Operations maintains an active technical and business information
relationship with approximately 80 OEM customers.
The Company also designs and markets Microsoft® Mouse pointing and editing devices. Microsoft
Press has published 27 books since it commenced operations in 1983, including Running MS-DOS®, by
Van Wolverton and The Peter Norton Programmer’s Guide to the IBM PC, by Peter Norton.

14

Company Organization
Microsoft’s business strategy emphasizes the development of a product line of microcomputer
software marketed through multiple channels of distribution. To this end, the Company is organized into
seven operating groups: Systems Software, Applications Software, Press, Hardware, OEM Sales, Retail
Sales, and International Operations. The Systems Software and Applications Software groups are
responsible for the design and development of products and the management of the marketing efforts for
those products. Microsoft Press publishes computer books and manages the marketing and distribution.
The Hardware group designs hardware products, subcontracts their production, and manages themarketing. The OEM Sales group is responsible for the marketing of systems, applications, and hardware
products through the domestic OEM channel. The Retail Sales group performs marketing and distribution
through the domestic retail channel, including the marketing of Microsoft Press books. The International
Operations group markets and distributes systems and applications products, both domestic and foreign
language versions, and hardware products in foreign countries. The Company has recently formed a newgroup—CD ROM Software—to pursue the research and development of this technology. See“Business—Product Development.”
The following table sets forth the percentage contribution to net revenues for each of the Company’s
product groups and channels of distribution for the year ended June 30, 1985.
Product Groups
Systems…………….…..
Applications…………....
Hardware and Books.…..
Total……….….....

Channels of Distribution
Domestic. OEM…………….
31%
Domestic Retail………..…...
36
International OEM…….……
19
International Retail…….…...
13
Press………………………..
1
Total………….……… 100%

54%
38
8
100%

Products
There are two basic categories of microcomputer software: systems software and applications
software. Systems software can be divided into two subcategories: operating systems and languages.
Operating systems control the hardware, allocate computer memory, schedule the execution of
applications software, and manage the flow of information and communication among the various
components of the microcomputer system. Microcomputer language programs, which contain instructions
regarding the syntax and rules of a particular computer language, allow the user to write programs in aparticular computer language and translate programs into a binary machine-readable set of commands
which activate and instruct the hardware. Common microcomputer languages include BASIC, “C”,
FORTRAN, COBOL, Pascal, and machine languages.
Applications software provides the microcomputer with instructions for the performance of end user
tasks. General or “horizontal,” as contrasted with specific or “vertical,” applications software is designed
for use by a broad class of end users, regardless of business, industry, or market segment. Primary
examples of general applications software are word processing programs and spreadsheet programs.

15

Systems Software
OPERATING SYSTEMS
Microsoft markets three proprietary operating systems for microcomputers: Microsoft MS-DOS,
Microsoft XENIX, and Microsoft MSX-DOS®. Microsoft MS-DOS is today a single-user, single-tasking
operating system designed initially for the IBM PC microcomputer with its 16-bit Intel® 8088
microprocessor chip. Since its introduction in 1981, it has been modified for newer Intel microprocessor
chips, for the accommodation of additional peripheral hardware devices, and to meet the needs ofapplications software developers. Recent versions of MS-DOS support file sharing and networking
between microcomputers. The current version of Microsoft MS-DOS includes a file system, a program
loader, a memory manager, user utilities, and a BASIC Interpreter program.
Management believes that more of the widely used business applications programs run on Microsoft
MS-DOS than on any other 16-bit microcomputer operating system. According to industry publications,
Microsoft MS-DOS is running on over four million microcomputers as of December 31, 1985. Microsoft
MS-DOS is available on IBM, Tandy, COMPAQ, Olivetti, AT&T, Zenith, Wang, Hewlett-Packard, DEC,and other IBM compatible microcomputers. Microsoft has adapted the product to support certain foreign
language character types, including European, Chinese, Kanji and Hangeul.
In November 1985, Microsoft began shipping Microsoft Windows, a graphical operating environment which runs on the Microsoft MS-DOS operating system. As an extension of MS-DOS, Microsoft
Windows manages such hardware as the keyboard, screen, and printer. This product allows new
applications programs to present themselves in a standard and graphical manner that is independent ofvideo or other output devices. Microsoft is encouraging independent software developers to create
applications programs which will take advantage of Microsoft Windows graphical user interface features.
Lotus Development recently announced its intent to pursue the development of applications products thatwill run on Windows. Microsoft’s own new applications software will be based on Microsoft Windows. It
is too early in the life of Microsoft Windows to determine what level of acceptance it will attain in themarketplace.
Microsoft Networks, shipped in 1984, is a local area networking program which enables the end user
to share files, disks, printers, and other devices within a networked Microsoft MS-DOS operating system
environment.
Microsoft also has developed and markets Microsoft XENIX, which is a UNIX-based multi-user
microcomputer operating system designed for the type of tasks traditionally undertaken by aminicomputer system. These include transaction oriented data processing tasks such as payroll systems
and accounts receivable management. Microsoft XENIX is also used in a single-user fashion by scientists,
engineers and programmers. As is the case with Microsoft MS-DOS, Microsoft has modified XENIX
several times since its 1980 introduction to take advantage of newer 16-bit and 32-bit microprocessors.
Microsoft introduced its third operating system, Microsoft MSX-DOS, in 1984. Microsoft MSXDOS is a single-user operating system which works in conjunction with an 8-bit computer whose
hardware and software specifications have been established by Microsoft. The MSX® computers havebeen sold primarily in the Japanese home computer market. The Microsoft MSX-DOS operating systemruns on an optional disk drive unit which can be attached to an MSX computer.
LANGUAGES
Microsoft has developed and markets numerous microcomputer language products. These products
come in the form of interpreters and compilers. An interpreter stores a condensed version of the sourcecode in memory and interprets it each time it executes the program. A compiler translates in a line-by-line
manner programs written in human readable or source code form into instructions in binary machinereadable or object code form. Compiled programs run faster and generally occupy less space in memory
than interpreted programs. Users can write, edit, and debug programs interactively with an interpreter andthen compile the final product for faster execution.
16

The Company’s first product, which the Company believes was the first commercially available
computer language program written for a personal computer, was a BASIC Interpreter developed in 1975
for the MITS ALTAIR microcomputer. BASIC is a general-purpose microcomputer programming
language. The Microsoft BASIC Interpreter has been enhanced from its original 8-bit implementation to
16-bit versions for MS-DOS and XENIX operating systems and the Apple Macintosh.
First shipped in 1979, the Microsoft BASIC Compiler has also been enhanced through the years. In
1981 the Microsoft® GW-BASIC® Compiler, with its enhanced graphics capabilities, was introduced. In
1985 the Company shipped its newest BASIC product, Microsoft QuickBASIC Compiler, which is fasterthan earlier versions and can take advantage of the extended features of the newer versions of MS-DOS.
“C” is a language often used by professional programmers to write operating systems and othersystems software and applications programs. Microsoft began marketing a C compiler in the Spring of
1983 and in early 1985 began shipping an enhanced version of a Microsoft developed product. The
Company uses its C Compiler extensively for developing its software products.
The Microsoft FORTRAN Compiler is used primarily in scientific and engineering work because of
its ability to manage complicated numerical calculations. Introduced in 1977 as an OEM product and in1980 as a retail product, Microsoft FORTRAN Compiler has been enhanced and runs on the MS-DOS
and XENIX operating systems. Microsoft also markets a FORTRAN product for the Apple Macintosh.
COBOL is a programming language most often used in commercial data processing and othertransaction processing applications. Microsoft introduced its Microsoft COBOL Compiler in the Fall of
1978 for 8-bit microcomputers and has developed newer versions for 16-bit systems using the MS-DOS
and XENIX operating systems.
Pascal was created as a language to teach good programming practices and its greater control
structures facilitate a structured programming method useful for creating larger programs. Microsoft
introduced the Microsoft Pascal Compiler in 1981 and its current version, released in the Fall of 1985,
runs on the MS-DOS and XENIX operating systems.
Microsoft Macro Assemblers, machine language products, allow a user to write programs inmachine-readable instruction form, thus permitting flexibility in programming and utilization of amachine’s particular capabilities. Microsoft markets a Macro Assembler which generates machinereadable code for Zilog Z-80® and Intel 8080 microprocessor-based machines and another which
generates such code for Intel 8086/8088 and 80186/80286 microprocessor-based machines.
Applications Software
Microsoft offers general, or “horizontal,” business applications software in each of six businessapplications categories: word processing, spreadsheet, file management, graphics, communications, andproject management. Certain Microsoft business applications products running on MS-DOS can sharedata, such as Multiplan and Chart or Multiplan and Access. All Microsoft business applications runningon the Apple Macintosh can share data with each other.
Word Processing. Microsoft Word, a graphics-based word processing product, runs on theMicrosoft MS-DOS and XENIX operating systems and the Apple Macintosh. Introduced in 1983, theproduct is also available in seven European language versions for the MS-DOS operating system and theApple Macintosh. Microsoft Word Version 2.0 supports the latest and most advanced output devices,
including laser printers, graphics cards, and monitors. It gives the user access to multiple windows,
allowing simultaneous access to more than one document. It can be used with a mouse for editing. Its
formatting capabilities facilitate organization and assembly of documents. The network version of
Microsoft Word allows the sharing of word processing capabilities and files among networked
microcomputers.
Spreadsheets. Microsoft Multiplan is available on over 70 different microcomputers and has beentranslated into 13 foreign languages. It was introduced in the Summer of 1982 and over one million
copies had been distributed through December 31, 1985. Microsoft Multiplan is designed to create and17

process large amounts of information quickly. The product can be used with a mouse pointing device,linked to Microsoft Chart to generate presentation quality graphics, and can directly read and write Lotus®
1-2-3® files. Multiplan allows the linking of several spreadsheets and offers 49 mathematical, statistical,
trigonometric and financial functions. In October 1985 Microsoft began shipping Version 2.0, which has
a number of new features, including a macro capability that allows users to automate complex tasks.
In October 1985 Microsoft introduced Microsoft Excel, a spreadsheet integrated with database andbusiness graphics modules for use on the Apple Macintosh computer. Microsoft Excel’s charting
capabilities can be linked to its spreadsheets to allow simultaneous changes to charts as changes are madeto the spreadsheets. Microsoft Excel offers 85 mathematical, statistical, trigonometric and financial
functions. Its data base module has sorting and searching capabilities. Extensive formatting capabilities
allow the user to highlight any entry. The product is available in European language versions as well.
File Management. Microsoft File for the Apple Macintosh allows the user to create text andgraphics files, prepare reports and forms, display information from the files, and search and sort up tonine items simultaneously. Microsoft File allows the sharing of data between other Macintosh software
programs such as Microsoft Multiplan, Microsoft Chart and Microsoft Word. This product was
introduced in January 1985 and three European language versions were introduced in the Spring of 1985.
In December 1985 the Company began distributing Microrim® Rbase 5OOO™, a data base management
product, in the European market under the name Microsoft Rbase.
Graphics. Microsoft Chart offers a wide variety of chart types, patterns and colors and runs on asubstantial number and variety of printers and plotters. The product can be linked to share data withwidely used spreadsheet and database software programs. Microsoft Chart has been translated into two
European languages for the MS-DOS operating system and into five languages for the Apple Macintosh.
Communications. Microsoft Access, a business information access program for use on MS-DOS
based microcomputers, conducts electronic communications with other computers in asynchronous mode,
including information retrieval systems such as Dow Jones News/Retrieval®, Compuserve®, andNewsNet®. Microsoft Access allows information sharing between computer programs and provides
windows which allow the user to view information in eight spaces simultaneously. The product also
provides custom menus to simplify the interface of many major commercial information services andpermits the user to create menus for specialized communications. Microsoft shipped this product inAugust 1985.
Project Management. Microsoft Project is a critical path method (“CPM”) project scheduling andresource allocation program designed for use on Microsoft MS-DOS-based computers. The product canperform as a budgeting, monitoring and cost estimating tool for large projects and as a critical path andschedule planning tool. Microsoft Project can be used with a mouse for editing and can share data withother software programs such as Microsoft Multiplan, Microsoft Chart and Lotus 1-2-3. Microsoft
introduced this product in April 1984 for the IBM PC and enhanced it in December 1985 to include PERT
charting and computer-based training, among other new features.
Hardware
The Company’s major hardware product is the Microsoft Mouse, a handheld pointing device whichfacilitates editing of text on the screen. It can be used with MS-DOS based machines and works withmany Microsoft applications products. It also has been adapted to be used with other companies’ software
products such as Lotus 1-2-3. The mouse for the IBM PC was introduced in the Spring of 1983 andseveral newer versions have been released.
Microsoft has marketed memory expansion boards (RAMCard®) for the Apple II and IIe and the
IBM PC and PCjr and a co-processor card (SoftCard®) for the Apple II, IIe and III, but does not foreseesignificant future distribution of those products.
Hardware products accounted for less than 10% of the Company’s revenues and earnings in fiscal
1985.
Books
18

Founded in 1983, Microsoft Press publishes books about the products of Microsoft and othersoftware developers and about current developments in the microcomputer industry. The 27 books
published as of December 31, 1985 include Running MS-DOS®, by Van Wolverton; The Peter Norton
Programmer’s Guide to the IBM PC, by Peter Norton; and The Apple Macintosh Book, by Cary Lu.
Books published by Microsoft Press are typically written and copyrighted by independent authors
who submit their manuscripts to the Company for publication and who receive a royalty from theCompany which is tied to the book’s sales.
Marketing and Distribution
Microsoft markets its software and hardware products through four primary channels of distribution:
domestic OEM, domestic retail, international OEM, and international retail.
Domestic OEM Distribution
The Company’s operating systems are marketed primarily to OEMs, under agreements which grant
the OEM the right to make copies of the product and distribute the copies with the OEM’s
microcomputer. The Company also markets its language and application programs to OEMs under similararrangements. In addition, the Company sells its standard packaged products to OEMs for resale to buyersof the OEMs’ computers. In almost all cases, the products are distributed under Microsoft trademarks.
The OEM generally pays the Company based on the number of copies of the product it makes or thenumber of microcomputers it ships, with an initial minimum commitment fee. The Company has OEM
agreements covering one or more of its products with virtually all of the major domestic microcomputer
OEMs, including IBM, Tandy, COMPAQ, Olivetti, AT&T, Zenith, Wang, Hewlett-Packard, and DEC.
Domestic Retail Distribution
Distributors and Dealers. The Company markets its products in the retail channel throughindependent distributors and dealers, large volume dealers such as Computerland and Businessland, anddealers who emphasize large business customers. A majority of the Company’s distribution is throughfive independent, non-exclusive distributors — Softsel Computer Products, First Software, Ingram
Software Distribution Services, Micro D, and Gates Distributing. Certain dealers who commit to takespecified actions to target large business end user customers are eligible to participate in the Company’s
Corporate Key Dealer Program, under which they obtain products directly from the Company and are
given incentives in return for their commitments to train and support these customers.
Microsoft has a network of field sales representatives and field support personnel who solicit orders
from dealers and distributors, provide product training to dealers and large business customers, andprovide sales support. As of December 31, 1985, Microsoft had five regional offices in operation in the
United States, staffed with 45 field sales and support personnel.
Direct Marketing. In recognition of the importance of obtaining large orders from corporate
customers, Microsoft has established a National Accounts Group to coordinate with Corporate Key
Dealers to market applications products directly to those customers. While several contracts have beensigned recently, to date no significant revenues have been generated by the program. The Company has
structured a similar program to coordinate with value added resellers to sell products to various
government agencies. The Company also markets its applications products to colleges and universities.
These institutions can market the products to their students, professors, and other employees. The
Company had entered into agreements with 30 colleges and universities as of December 31, 1985.
International OEM Distribution
The Company distributes to and maintains an active business and technical information relationshipwith a number of Japanese microcomputer manufacturers, including NEC, Mitsubishi, Matsushita, Tokyo
Sanyo, Fujitsu, Kyocera, Epson, and Toshiba. In fiscal 1985, customers in Japan accounted forapproximately 12% of the Company’s net revenues, mostly from Japanese OEMs who shipped Microsoft
products with their microcomputers. The Company markets its products in Japan and South Korea
19through exclusive sales representative arrangements. The Company’s independent sales agent in Japan is
ASCII Corporation (“ASCII”), and in South Korea it is QNIX Microsoft, A former officer and director of
the Company is a major shareholder and officer of ASCII. See “Certain Transactions.” The agentsreceive commissions for sales in their respective territories. ASCII represents the Company for both OEM
and retail sales, while QNIX Microsoft handles only OEM sales.
The Company’s exclusive sales representative agreement with ASCII terminates on or before March
17, 1986. Microsoft formed a wholly-owned subsidiary in Japan, Microsoft K.K., in February 1986
involving start-up costs of approximately $2,000,000. The subsidiary will handle the existing OEM
business and potential retail business in Japan. The Company and ASCII have entered into an agreement
for retail business during a transition period ending June 30, 1986 and are negotiating for a transition
agreement for OEM business. It is possible that this transition will cause a disruption in the Company’s
Japanese business which will adversely affect net revenues in Japan.
OEM marketing, and business and technical relations with European OEMs, including Siemens,
Philips, Ericsson, Triumph Adler, ACT, Bull Mircal, and SMT Goupil, are primarily handled by theMicrosoft subsidiaries in their respective territories, who are assisted by the International Operationsgroup at Company headquarters. Headquarters personnel also handle the Company’s OEM marketing
efforts to Southeast Asia, Latin America, and other markets.
The Company bills its international OEM customers in U.S. dollars and therefore payment is not
subject to currency exchange fluctuations.
International Retail Distribution
In general, retail distribution has been the Company’s larger source of revenue in Europe, Canada,
and Australia and only a relatively minor revenue generator in the Far East and other areas. Microsoft hasa practice of “localizing” its retail products, including user messages and documentation, for distribution
in those countries. Thus, in France all user messages and documentation are in French and all monetaryreferences are in French francs, and in the United Kingdom monetary references are in pounds and user
messages and documentation reflect certain British conventions. Various Microsoft products have also
been localized for distribution in West Germany, Italy, Spain, Portugal, Scandinavia, the Netherlands andLatin America. See the Microsoft Software Product Line chart inside the front cover page of thisProspectus for an indication of which products have been localized.
The Company has established marketing, distribution, and support subsidiaries in Canada, theUnited Kingdom, West Germany, France, and Australia and has marketing and support subsidiaries in
Sweden and Italy. In addition to retail marketing activities, the subsidiaries also deal directly with OEMsin their territories, as discussed in the preceding section. Another subsidiary operates a manufacturing
facility in Dublin, Ireland which supplies packaged products for the Company’s European operations. The
Irish manufacturing facility shipped its first products in December 1985.
The Company’s international operations, both OEM and retail, are subject to certain risks common
to foreign operations in general, such as governmental regulations and import restrictions. For further
information with respect to the Company’s international revenues, see Note 8 of the Notes toConsolidated Financial Statements.
Microsoft Press
Microsoft Press contracts with an independent commercial printer for the manufacture of its books.
Harper & Row Publishers, Inc. acts as the Company’s fulfillment house in the United States, maintaining
the majority of the inventory of Microsoft Press books. Books are marketed to the traditional book tradeby independent sales representatives and by Microsoft Press sales personnel. Sales to non-traditional
channels — primarily computer stores — are handled by the Company’s software retail sales force.
Internationally, Microsoft Press has agreements with publishers in France, Germany, Italy, theNetherlands, Sweden, Spain, and Japan for the worldwide distribution of its books in the respective
foreign languages. Microsoft Press has granted to a publisher in England the right to distribute English
language versions of its books in all countries except the U.S. In most cases, Microsoft Press provides
20each publisher with a book’s manuscript and the publisher arranges for its translation, and the printing,
distribution, and marketing of the translated version.
Customers
The Company believes that most of its end user customers are individuals in businesses, both small
and large, representing a variety of industries, government agencies, and educational institutions. Theseend users obtain Microsoft products primarily through distributors, dealers, and OEMs who include
certain Microsoft products with their hardware. See “Business — Marketing and Distribution.” No single
customer accounted for more than 10% of the Company’s revenues in fiscal 1985.
Product Development
The microcomputer software industry is characterized by rapid technological change, which requires
a continuous high level of expenditures for the enhancement of existing products and the development of
new products. The Company is committed to the creation of new products and intends to continue theenhancement of its existing products.
Most of the Company’s software products are developed internally. Product documentation is also
created internally. Internal development enables Microsoft to maintain closer technical control over the
products and gives the Company the freedom to designate which modifications and enhancements aremost important and when they should be implemented. The Company has created a substantial body ofproprietary development tools and has evolved a development methodology for the creation andenhancement of its products. These tools and methodology are also designed to simplify a product’s
portability among different operating systems or computers.
The Company believes that a crucial factor in the success of a new product is getting it to market
quickly to respond to a new user need or an advance in hardware design, without compromising productquality. The Company strives to become as fully informed as possible at the earliest possible time about
technological advances and changing usage patterns. The Company recently hired a Vice President, CD
ROM Software to direct the Company’s exploration of the potential of CD ROM (Compact Disk Read
Only Memory) technology in the microcomputer industry. See “Management—Certain Transactions.”
CD ROM technology may never generate revenue or profit for the Company, but may allow the Company
to produce products incorporating that technology if and when such a market emerges.
As of December 31, 1985, the Company employed 271 persons engaged full time in softwaredevelopment. During fiscal 1983, 1984 and 1985, the Company spent approximately $7,021,000,$10,665,000, and $17,108,000, respectively, on product development and enhancement activities. Thoseamounts represented approximately 14%, 11%, and 12%, respectively, of net revenues in each of those
years. Management presently anticipates that product development and enhancement expenditures willcontinue at approximately the present level as a percentage of net revenues.
When the Company licenses a software product from an independent author, it typically pays theauthor a percentage royalty based on net revenues generated by the product. Royalties to independent
software authors totaled $3,222,000, $2,801,000, and $3,736,000 in fiscal 1983, 1984, and 1985, respectively. The bulk of those payments related to the XENIX operating system and the Company’s Flight
Simulator game product. Microsoft XENIX is based on AT&T’s UNIX operating system, which theCompany licenses from AT&T. Microsoft has customized UNIX for, primarily, Intel microprocessor
architecture and enhanced it for office use.
The specifications for the Company’s hardware products are typically created internally, while
production is subcontracted.
Employees
As of December 31, 1985, the Company employed 998 people, 840 domestically and 158
internationally. Of the total, 326 were in product development, 402 in sales, marketing and support, 113
in manufacturing and distribution, and 157 in finance and administration. Microsoft’s success is highly21

dependent on its ability to attract and retain qualified employees. Competition for employees is intense in
the software industry. To date the Company believes it has been successful in its efforts to recruit
qualified employees, but there is no assurance that it will continue to be successful in the future. None of
the Company’s employees is subject to collective bargaining agreements. The Company believes that
relations with its employees are good.
Competition
The microcomputer software market is highly competitive and has been subject to rapid change,
which can be expected to continue. The Company’s competitors include many independent software
vendors, such as Lotus Development, Ashton-Tate, Software Publishing, and Borland International, as
well as a number of microcomputer manufacturers which are devoting significant resources to creating
microcomputer software, notably IBM, AT&T, and Apple Computer. Many of the Company’s competitors have financial, marketing, and technological resources which exceed those of the Company.
Microsoft markets its operating systems products primarily to OEMs. The Company competes forthat business with other independent systems software vendors, such as Digital Research and AT&T, andwith the OEMs themselves to the extent that they may be developing their own systems software. The
Company believes that the principal competitive factors in marketing to OEMs are the product’s
reputation, product features and functions, timeliness of delivery, product reliability, and availability andquality of support services.
Microsoft’s language products are primarily marketed through the retail distribution channel. Mostof the Company’s language products, including Microsoft FORTRAN, Microsoft C, and Microsoft
BASIC Compilers, are relatively high-priced in relation to languages offered by competitors, and are
directed at end users who demand a high degree of functionality from a language product and will pay forthe extra features. There is and will continue to be price pressure on these products as lower priced
competing offerings become more fully featured. Other language products, such as Macro Assembler,
QuickBASIC, and MacBASIC, are lower priced versions for end users who do not need all of the features
available in the Company’s other language products. The market for these products is quite pricesensitive.
The Company’s application products are also marketed primarily through the retail channel. All of
the Company’s applications products are opposed in the marketplace by competing products offering
many similar features. The Company believes that the principal competitive factors in the applications
products market include product features and functions, ease of understanding and operating the software,
product reliability, price/performance characteristics, name recognition, and availability and quality of
support and training services.
To date price competition has not been a major factor in the microcomputer software market. It
seems likely to management, however, that price competition, with its attendant reduced profit margins,
will emerge in the next few years as a significant consideration. The recent increase of “site licenses”(permitting copying of the program and documentation) and discount pricing for large volume retailcustomers is evidence of such competition.
Microsoft also competes with other companies in the microcomputer software market for
distributors, dealers, and other channels of product distribution. In addition to the factors listed above, theprincipal considerations for distributors and dealers in determining which products to offer include profit
margins, product support and service, and credit terms.
Manufacturing
The Company has manufacturing facilities located in the United States and the Republic of Ireland.
The Company’s manufacturing operations involve the duplication of diskettes, assembly of purchased
parts, and final packaging. Quality control tests are performed on purchased parts, duplicated diskettes,
and finished products. The chief materials and components used in Microsoft products include diskettes,
plastic boxes, binders, and multi-color printed materials. The Company is often able to acquire22component parts and materials on a volume discount basis. The Company has multiple sources for raw
materials, supplies, and components.
Disk duplicating and labeling are highly automated. Final assembly of the products is labor
intensive. All manufacturing operations are equipped with computerized inventory, manufacturing,
management, and financial control systems.
Properties
The Company’s executive offices are located at 16011 NE 36th Street, Redmond, Washington, infour adjacent leased buildings having a total of 240,000 square feet of space. The land and buildings areleased under a 15 year lease, with two five-year options to renew. The Company also has a 73,000 squarefoot manufacturing, assembly, and shipping facility at another site in Bellevue, a 25,000 square footproduct distribution center in nearby Kirkland, Washington, and a 36,000 square foot manufacturing,assembly, and shipping facility in Dublin, Ireland. All of these facilities are leased.
In addition, the Company leases office space in 24 locations in the United States and in 7 foreigncountries (Australia, Canada, England, France, Italy, West Germany and Sweden). These locations
function primarily as sales, training, and field service centers for their regions.
All of the Company’s properties are leased from unaffiliated third parties.
The Company believes that its new headquarters complex is adequate for its present needs. A
contiguous site is under option for expansion.
See Note 6 of Notes to Consolidated Financial Statements for information regarding the Company’s
obligations under leases.
Product Protection
Microsoft regards its software as proprietary and attempts to protect it with copyrights, trade secretlaws, and internal nondisclosure safeguards, as well as restrictions on disclosure and transferability thatare incorporated into its software license agreements. The Company licenses its software products tocustomers rather than transferring title. Despite these restrictions, it may be possible for competitors orusers to copy aspects of the Company’s products or to obtain information which the Company regards as
trade secrets. Computer software generally has not been patented, and existing copyright laws afford
limited practical protection. Monitoring and identifying unauthorized use of such a broadly disseminatedproduct as microcomputer software is difficult, and software piracy can be expected to be a persistentproblem for the packaged software industry. These problems may be particularly acute in international
markets. For that reason, most of the Company’s products distributed internationally have electronic copy
protection methods embedded in the disks.
Microsoft seeks patent protection on new products in appropriate circumstances, and has two patentapplications pending.
Legal Proceedings
Microsoft was served in January 1986 with a summons and complaint in an action commenced by
Seattle Computer Products, Inc. (“SCP”) in the Superior Court for King County, Washington. This action
arises out of an agreement entered into in 1981 under which SCP sold to Microsoft SCP’s rights in a disk
operating system which Microsoft developed into MS-DOS. SCP seeks the following relief: (i) a judicial
declaration that under the agreement SCP has an assignable, perpetual, royalty-free worldwide licensefrom Microsoft for MS-DOS in its current and future versions; (ii) an injunction against Microsoft
prohibiting alleged interference with SCP’s attempts to sell its business and requiring Microsoft to honor
SCP’s interpretation of the agreement; and, in the alternative, (iii) judgment against Microsoft fordamages “believed to exceed $20,000,000” or $60,000,000 when trebled or a rescission of the agreement,a return of the rights granted thereunder, and an accounting for the payment to SCP of all revenues
received from Microsoft’s marketing of MS-DOS. The Company believes that SCP’s interpretation of theagreement is erroneous and intends to vigorously defend this action. In the opinion of the Company, were
23

SCP to prevail on its requested declaratory or injunctive relief (see items (i) and (ii) above), such a result
would not have a material adverse effect on the Company’s financial condition or results of operations.
Although the outcome of litigation can never be predicted with certainty, the Company further believes
that it is unlikely that SCP could obtain the relief sought with respect to damages or rescission of thecontract (see item (iii) above).

24

MANAGEMENT
Directors and Executive Officers
The directors and executive officers of the Company are as follows:
Name
–——

Age
–—

William H. Gates III
Jon A. Shirley
Francis I. Gaudette

30
47
50

Steven A. Ballmer
Ida S. ColeJames W. Harris
Thomas M. Lopez
William H. Neukom
Scott D. Oki
Jean D. Richardson
Gerald A. Ruttenbur
Portia Isaacson
David F. Marquardt

29
38
42
42
44
37
49
42
43
37

Position With Company——————————

Chairman of the Board, Chief Executive Officer
President and Chief Operating Officer; Director
Vice President, Finance and Administration,
Chief Financial and Administrative Officer
Vice President, Systems Software
Vice President, Applications Software
Vice President, OEM Sales
Vice President, CD ROM Software
Vice President, Law & Corporate Affairs
Vice President, International Operations
Vice President, Corporate Communications
Vice President, Retail Sales
Director
Director

All directors hold office until the next annual meeting of stockholders and the election andqualification of their successors. Directors receive no compensation for serving on the Board except for
reimbursement of reasonable expenses incurred in attending meetings. Officers are elected annually by
the Board of Directors and serve at the discretion of the Board.
Mr. Gates was a founder of the Company and has been its Chief Executive Officer and Chairman of
the Board since the Company’s predecessor partnership was incorporated in 1981. From 1975 to 1981,
Mr. Gates was a partner with Paul Allen, Microsoft’s other founder, in the predecessor partnership. Mr.
Gates is responsible for technical development including product design and internal development andreview.
Mr. Shirley joined Microsoft as President, Chief Operating Officer, and a director in August 1983,
after 25 years with Tandy Corporation. At Tandy, Mr. Shirley was Vice President, Computer
Merchandising, from 1978 until 1983, and prior to 1978 held a variety of positions at Tandy in sales,
merchandising, manufacturing, and international operations. Tandy Corporation is a leading supplier of
personal computers and consumer electronics products.
Mr. Gaudette joined Microsoft in September 1984 as Vice President, Finance and Administration.
Mr. Gaudette joined Microsoft from C3, Inc., where he served as Vice President, Finance andAdministration from 1981 to 1984. Prior to C3, Gaudette was with Informatics General, where he served
as Vice President, Business Operations, of the Information Services Group. In addition, he has held senior
management positions with Computer Network Corporation (COMNET); Rexnord, Inc.; Rockwell
International; and Frito-Lay, Inc.
Mr. Ballmer has been Vice President, Systems Software since 1984. Since joining the Company in1980, Mr. Ballmer has also served as Assistant to the President, Vice President, Corporate Staffs, andVice President, Marketing. Before coming to Microsoft, Mr. Ballmer worked in marketing for The
Procter & Gamble Company.
Ms. Cole joined Microsoft as Vice President, Applications Software in February 1985. Prior tojoining the Company, Ms. Cole spent four years at Apple Computer. At Apple, her most recent position
was Director of New Product Development, and she also served as Director of Marketing for Apple II and
III product lines, Director, Applications Software, and Manager, Applications Software Development.

25

Mr. Harris joined Microsoft in January 1983 as General Manager, OEM Sales and was promoted toVice President, OEM Sales shortly thereafter. Prior to joining the Company, Mr. Harris was Marketing
Manager in the Software Distribution and Support Operation at Intel Corporation, a position he held from1980 to 1982. From 1982 to 1983, Mr. Harris was chairman of Intel’s Strategic Business Section, where
he was responsible for strategic business and product planning.
Mr. Lopez joined the Company in January 1986. From November 1984 until joining Microsoft, Mr.
Lopez was President and founder of Cytation, Inc., which was involved in the development of CD ROM
applications products. From 1981 until 1984, Mr. Lopez was employed by Activision, Inc., first as Vice
President, Editorial Development and later as Senior Vice President. Prior to that, he was Director ofStrategic Planning for J. Walter Thompson Company, an advertising agency.
Mr. Neukom joined the Company in December 1985 as Vice President, Law and Corporate Affairs.
Mr. Neukom formerly was a member of the Seattle law firm of Shidler MeBroom Gates & Lucas, theCompany’s general counsel. He served as the Company’s senior outside counsel from 1979 until 1985.
He engaged in the private practice of law from 1968 until joining the Company.
Mr. Oki has served as the Company’s Vice President, International Operations since 1983. He was
hired by Microsoft in 1982 as Marketing Manager, Special Accounts. From 1980 to 1982, Mr. Oki wasVice President for Product Development with Sequoia Group, Inc., a developer of turnkey computer
systems for physicians. Six months after Mr. Oki joined Microsoft, Sequoia Group filed a petition inbankruptcy. Prior to 1980, he held marketing positions with Hewlett-Packard.
Ms. Richardson joined Microsoft as Vice President, Corporate Communications in February 1985
after eight years with Apple Computer. Ms. Richardson joined Apple in 1978 as Marketing Services
Manager and was responsible for the creation of its Marketing Communications Group. In 1982 shebecame Apple’s Director of Marketing Communications.
Mr. Ruttenbur joined Microsoft in March 1984 as Vice President, Retail Sales. Mr. Ruttenbur cameto Microsoft from Koala Technologies Corporation, a producer of hardware and software formicrocomputers, where he was Vice President of Sales from 1983 to 1984. From 1982 to 1983, Mr.
Ruttenbur was Director of National Sales for Atari’s Home Computer Division. Prior to 1982, Mr.
Ruttenbur spent 12 years with M&M Mars Distributing in various sales and marketing positions.
Ms. Isaacson has been a director of the Company since December 1985. She is currently Chairman
and Chief Executive Officer of Intellisys Corporation, a home automation software system company andis also head of Isaacson, Incorporated, a merger and acquisition firm. In 1981 Ms. Isaacson founded
Future Computing, a market research company, and was its Chief Executive Officer until October 1985,
when she became its Vice Chairman of the Board.
Mr. Marquardt has been a director of the Company since 1981. Since 1980, Mr. Marquardt has been
a general partner of TVI Management, TVI Management-2, and TVI Management-3, which are generalpartners of Technology Venture Investors, Technology Venture Investors-2, and Technology Venture
Investors-3, venture capital limited partnerships. He has been with TVI Management since 1980. He is
also a director of Archive Corporation and Sun Microsystems, Inc.

26

Executive Compensation
The following table sets forth the cash compensation paid by the Company to its five highest paid
executive officers, and to all executive officers as a group, during the year ended December 31, 1985:
Name

Jon A. Shirley
William H. Gates III
Francis J. GaudetteWilliam S. Roland (2)Capacity in Which Served

Cash Compensation (1)President and Chief Operating Officer; Director
Chairman of the Board, Chief Executive Officer
Vice President, Finance and Administration,
Chief Financial and Administrative Officer
Vice President/General Manager, Peripherals andHardware Development
Vice President, Systems Software$ 228,000
133,000
109,000
96,000

Steven A. Ballmer
88,000All executive officers$1,127,000
as a group (12 persons) (3)————(1) Includes bonuses awarded under a bonus program for salaried employees. Messrs. Shirley and Gates
do not participate in the bonus program. Bonuses of up to 15% (20% in the case of one executive
officer) of base earnings are awarded on a discretionary basis.
(2) Mr. Roland has resigned effective February 1986.
(3) Includes two persons whose employment with the Company ended in March 1985.
1981 Stock Option Plan
All present and future employees who, at the time the options are granted, are regular full-time
employees of the Company are eligible to participate in the Option Plan. As of January 15, 1986, there
were options outstanding to purchase 2,681,457 shares of Common Stock and 39,896 shares remained
available for future grants. At its January 28, 1986 meeting the Board of Directors voted to increase
shares available for future grants by 200,000. The option price is determined by the Board of Directors,
subject to the provisions of the Option Plan. For incentive stock options, the option price cannot be lessthan the fair market value of the stock on the date of grant. For one year following the date of thisProspectus, the Company has agreed not to grant stock options at a price less than 85% of the fair market
value of the Common Stock on the date of grant. The Board of Directors determines the size of each
option and the vesting schedule. Options expire five years after grant, or following termination of
employment.
An option may be exercised by paying the option price in cash, in shares of Common Stock, or inany combination of cash and shares. When a non-qualified option is exercised, the option holder mustalso pay related taxes.
In calendar year 1985, the following executive officers were granted stock options under the Option
Plan for the indicated number of shares: Jon A. Shirley, 150,000 shares at an average exercise price of$5.50 per share; Francis J. Gaudette, 15,000 shares, average exercise price of $5.50 per share; all
executive officers as a group (12 persons), 302,499 shares, average exercise price of $4.51 per share.
In calendar year 1985, the following executive officers exercised stock options granted under the
Option Plan. The dollar amounts in parentheses indicate the net value of the shares purchased (market
value as of the exercise date less option price): Jon A. Shirley, 22,500 shares (net value of $65,000); all
executive officers as a group (12 persons), 45,312 shares (net value of $99,218).
1986 Employee Stock Purchase Plan
The 1986 Employee Stock Purchase Plan allows all full-time employees to authorize payroll
deductions at a rate of 2, 4, 6, 8, or 10% of base pay (including bonuses) to be applied toward purchases
27

of Common Stock. There are 300,000 shares of Common Stock reserved for issuance under the PurchasePlan. The Purchase Plan will end on December 31, 1990.
Each offering period is six months, and new offerings commence on January 1 and July 1 of eachyear. An employee must authorize a payroll deduction before the start of an offering in order toparticipate in that offering, and if the employee has not withdrawn from the offering before its lastbusiness day he will be deemed to have exercised the option to purchase as many shares as his payroll
deductions will allow, at the option price. The option price is the lesser of 85% of (i) the fair market valueof the Common Stock on the first business day of the offering, or (ii) the fair market value on the lastbusiness day of the offering.
The Company anticipates that the first offering under the Purchase Plan will commence on or after
July 1, 1986.
Certain Transactions
In 1981, an executive officer and certain employees of the Company purchased Common Stock fromthe Company at a price less than the fair market value on the purchase date. The Company made loans tothese individuals to enable them to pay their income tax liability on the below-market purchases. The
loans bear interest at 7% per annum and are due and payable in July 1988. The following table includes
Mr. Ballmer’s obligation to the Company pursuant to such a loan.
Certain executive officers of the Company have entered into stock purchase agreements with theCompany whereby they have purchased Common Stock from the Company at the then-current fair market
value, as determined by independent appraisal, with the purchase price due and payable seven years fromthe date of the agreement. The unpaid purchase price bears interest at 9% per annum. The following table
includes Mr. Shirley’s obligation under such a stock purchase agreement.
Since January 1, 1985, the following directors and executive officers have purchased the indicatednumber of shares of Common Stock at the indicated prices: Ida S. Cole, Scott D. Oki, and Jean D.
Richardson, 16,667 shares, 6,667 shares, and 11,667 shares, respectively, at $3.00 per share; Portia
Isaacson, Thomas M. Lopez, and Jean D. Richardson, 10,000 shares, 7,500 shares, and 8,000 shares,
respectively, at $5.50 per share, and William H. Neukom, 35,000 shares at $17.50 per share. In all cases,
the purchase price was determined by independent appraisal.
The Company has made loans to employees for the purchase of stock and for the payment of taxes inconnection with stock purchases, and at times has made loans to new employees, primarily for the
purpose of assisting in the employee’s relocation. The following executive officers owed the Company inexcess of $60,000 at some time since the beginning of fiscal 1983:
Name of
Executive Officer

Jon A. Shirley……………………………..….………..
Francis J. Gaudette……………………..…..………….
Steven A. Ballmer……………………..…..….……….
Scott D. Oki…………………………..……..…………
Jean D. Richardson…………………..……..………….
Gerald A. Ruttenbur…………………………………...

28

Largest Amount Owed
from 7/1/82 to 12/31/85

Balance Owed
at 12/31/85

Interest
Rates (%)

$810,751
143,888533,711
198,711305,170
131,723$608,501
89,664
533,711
56,211
55,17023,241

9
9, 12
7
9, 12
9, 12
9, 12

Kazuhiko Nishi, a former director and executive officer of the Company, owed the Company$509,850 as of December 31, 1985, pursuant to loans in the principal amounts of $100,000 and $275,000
made in 1981 and 1983. Both loans bear interest at 12% per annum. The Company doubts repayment andhas accordingly fully provided for the uncollectibility of these loans. Mr. Nishi is a principal of ASCII
Corporation (“ASCII”), the Company’s exclusive sales representative in Japan. The Company is in theprocess of terminating that relationship. See “Business — Marketing and Distribution — International
OEM Distribution.” The Company’s agreement with ASCII, which has been in effect for a number ofyears, provides for the payment to ASCII of a 30% commission on OEM sales in its territory. Until
recently, ASCII’s territory was the Far East, but it was limited to only Japan in September 1985. ASCII
also handles the retail distribution, including manufacturing, of Microsoft products in its territory andpays Microsoft 30% of those revenues. In fiscal 1983, 1984, and 1985, Microsoft paid OEM commissions
to ASCII in the amount of $2,090,000, $4,377,000, and $5,179,000, respectively, and received less than
$1,000,000 in each of those years as its portion of ASCII’s retail Microsoft product revenues.
On January 6, 1986, when the Company hired Thomas M. Lopez as its Vice President, CD ROM
Software, it purchased from Mr. Lopez and one other individual all of the outstanding stock of a twoemployee CD ROM research and development company founded by Mr. Lopez. The acquired company’s
major asset was a CD ROM-related product which is in development. Mr. Lopez received $81,600 for his
stock, plus 1.8% of the revenues earned by Microsoft on any sales of the acquired company’s productduring the four years ending January 5, 1990. Mr. Lopez is entitled to a minimum of $30,000 in royalties
during the four-year period.
Mr. Gates’ father is a member of Shidler McBroom Gates & Lucas, the Company’s general counsel
since 1978. In fiscal 1983, 1984, and 1985, the law firm received legal fees and reimbursement ofexpenses from the Company in the amounts of $154,833, $216,932, and $536,532.
Loans outstanding at the present time have been approved by the majority of the disinterested andindependent directors. All future loans to officers, directors or employees will be approved by a majorityof the disinterested and independent directors. In the future the Company will not enter into anytransactions with affiliated parties unless the disinterested and independent directors determine that theterms of such transactions are at least as favorable to the Company as if made with unaffiliated parties.

29

PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information regarding the ownership of the Company’s
Common Stock as of January 15, 1986, (i) by each person who is known by the Company to own
beneficially more than 5% of the outstanding shares of the Common Stock, (ii) by each of the Company’s
directors, (iii) by all directors ard officers as a group, and (iv) by each Selling Stockholder. Unlessotherwise indicated below, the person or persons named have sole voting and investment power:
Shares Beneficially
Owned Prior to Offering
Percent
NumberDirectors,
Officers, and 5%
Stockholders

William H. Gates III (2) (3)Microsoft Corporation
16011 NE 36th Street
Redmond, WA 98073-9717
Paul G. Allen (3)Asymetrix Corporation
110-110th Avenue NE
Suite 617
Bellevue, WA 98004
Steven A. Ballmer
Microsoft Corporation
16011 NE 36th Street
Redmond, WA 98073-9717
Technology Venture
Investors 1, 2 & 33000 Sand Hill Road
Menlo Park, CA 94025
Jon A. Shirley
David F. Marquardt (5)Portia Isaacson
All Officers and Directors
as a Group (13 Persons)Shares To
Be Sold

Shares Beneficially Owned
After Offering (1)Percent
Number11,222,000

49.2%

80,00011,142,000

44.8%

6,390,000

28.0

200,000

6,190,000

24.9

1,710,001

7.5

30,0001,680,001

6.8

1,378,901 (4)6.1

294,893

1,084,008 (4)4.4400,000
21,099 (5)10,00013,521,099 (5)(6)

1.8
.1
—
59.1

60,0005,107—
175,107

340,000
15,992 (5)10,00013,345,992 (5)(6)

1.4
.1
—
53.6

114,000 (7).533,00081,000 (7).320,000.1

20,000——305,667
293,850
36,66634,000

1.3
1.3
.2
.1

10,00040,00015,0007,000

295,667
253,850
21,66627,000

1.2
1.0
.1
.1

Other Selling Stockholders

William H. andMary M. Gates
William H. Neukom, Trustee
for Kristianne Gates
Charles Simonyi
Gordon Letwin
Frederic H. Ballmer
Merritt Family Trust—————(1) Assuming no exercise of the Underwriters’ over-allotment option.
(2) By reason of his position with the Company and his beneficial ownership of Common Stock, Mr. Gates may be deemed to be a“parent” of the Company within the meaning of the Securities Act of 1933.
(3) Messrs. Gates and Allen were partners in the Company’s predecessor partnership, and may be deemed to be “promoters” of theCompany within the meaning of the Securities Act of 1933. They received their Common Stock in exchange for their transfer
to the Company of all of the assets and liabilities of the predecessor partnership. Mr. Allen was the Company’s Executive Vice
President from its inception until 1983, and also served as a director from inception through April 1985.
(4) The shares listed for Technology Venture Investors 1, 2 and 3 takes into account the automatic conversion of Preferred Stockinto 985,710 shares of Common Stock as of the date of this Prospectus.
(5) Mr. Marquardt is a general partner in TVI Management 1, 2, and 3 which are the general partners in the limited partnerships
Technology Venture Investors 1, 2, and 3. The shares listed opposite Mr. Marquardt’s name takes into account the automaticconversion of Preferred Stock into 14,290 shares of Common Stock. All shares listed for Mr. Marquardt are owned by TVIManagement 1, 2, and 3.
(6) Includes 77,914 shares subject to options which are exercisable within 60 days of January 15, 1986.
(7) Includes 40,000 shares held in trust for the benefit of Mr. and Mrs. Gates.

SHARES ELIGIBLE FOR FUTURE SALE
Immediately after the offering pursuant to this Prospectus, 21,996,017 shares of Common Stock willcontinue to be held by existing stockholders. All such shares of Common Stock, and shares to be issued
30

under outstanding stock options, were or will be acquired in reliance upon the “private placement”
exemption under the Securities Act of 1933 (the “Act”) (such outstanding shares of Common Stock beingreferred to as “Restricted Shares”). Of those Restricted Shares, 20,542,086 shares are owned by persons
who may be deemed to be affiliates of the Company. Restricted Shares may not be sold unless they are
registered under the Act or are sold pursuant to an applicable exemption from registration, including an
exemption under Rule 144. Beginning 90 days after the date of this Prospectus, Restricted Shares may besold in accordance with Rule 144 if the conditions of that Rule have been met. Restricted Shares may not
be sold under Rule 144 unless they have been fully paid for and held for two years. After such two-year
holding period, the shares may be sold in brokers’ transactions in an amount in any three months not inexcess of the greater of 1% of the number of shares of Common Stock then outstanding or the average
weekly trading volume for a four-week period prior to each such sale. After they have been paid for andheld for more than three years, Restricted Shares held by persons who are not affiliates of the Company
may be sold without limitation. However, under Rule 144, Restricted Shares held by affiliates must
continue, after the three-year holding period, to be sold in brokers’ transactions subject to the volume
limitations described above. The above is a summary of Rule 144 and is not intended to be a complete
description thereof. Approximately 230,000 Restricted Shares will be eligible for sale pursuant to Rule144 as of the date of this Prospectus.
A total of 2,921,353 shares of Common Stock are reserved for issuance under the Option Plan. See“Management — 1981 Stock Option Plan.” In addition, 300,000 shares of Common Stock are reservedfor issuance under the Purchase Plan. See “Management — 1986 Employee Stock Purchase Plan.” The
Company intends to file registration statements under the Act to register shares to be issued pursuant tosuch plans approximately 90 days after the date of this Prospectus, to become effective as promptly
thereafter as practicable. Shares issued upon exercise of outstanding stock options under the Option Planand Purchase Plan after the effective date of such registration statement generally may be sold in the open
market.
The Company, and the Selling Stockholders, officers, and directors, holding in the aggregate
approximately 21,070,000 shares of Common Stock, have agreed with the Underwriters not to offer, sell,or otherwise dispose of any shares of Common Stock for a period of 120 days after the date of thisProspectus without the prior written consent of the Representatives, except that the Company may,without such consent, grant options, or issue stock upon exercise of outstanding options, pursuant to the
Option Plan, and issue stock pursuant to the Purchase Plan.
Prior to this offering, there has been no market for the Common Stock, and no precise predictions
can be made of the effect, if any, that market sales of shares or the availability of shares for sale will haveon the market price prevailing from time to time. Nevertheless, sales of substantial amounts of theCommon Stock in the public market could adversely affect prevailing market prices.
DESCRIPTION OF COMMON STOCKThe Company is authorized to issue up to 60,000,000 shares of Common Stock, par value $.001 pershare. As of January 15, 1986, there were 22,791,017 shares of Common Stock outstanding, held ofrecord by 181 stockholders. The Common Stock is not entitled to any preemptive rights. The Common
Stock is neither redeemable nor convertible. Upon liquidation, the holders of Common Stock are entitledto share ratably in the entire net assets of the Company, after payment in full to all creditors of theCompany. All outstanding Common Stock is, and all Common Stock offered hereby will be, when issued,
fully paid and nonassessable. The holders of the Common Stock are entitled to dividends when and as31

declared by the Board of Directors, out of funds legally available therefor. Each holder of Common
Stockis entitled to one vote for each share of Common Stock held of record on all matters submitted to avote of stockholders, including the election of directors.
Registrar and Transfer Agent
The registrar and transfer agent for the Common Stock is The First Jersey National Bank, Jersey
City, New Jersey.

UNDERWRITING
Subject to the terms and conditions set forth in the Underwriting Agreement, the Company and the
Selling Stockholders have agreed to sell to each of the Underwriters named below, and each of theUnderwriters, for whom Goldman, Sachs & Co. and Alex. Brown & Sons Incorporated are acting as
Representatives, has severally agreed to purchase from the Company and the Selling Stockholders therespective number of shares of Common Stock set forth opposite its name below.
Number ofUnderwriter
SharesGoldman, Sachs & Co……………………………………… 440,500
Alex. Brown & Sons Incorporated…………………………. 440,500
ABD Securities Corporation………………………………...
15,000
Advest, Inc…………………………………………………..
15,000Allen & Company Incorporated…………………………….
15,000Arnhold and S. Bleichroeder, Inc…………………………...
15,000Robert W. Baird & Co. Incorporated……………………….
15,000Baker, Watts & Co…………………………………………..
6,000
Banque de Neuflize, Schlumber, Mallet…………………….
15,000
Barclays Merchant Bank Limited…………………………...
6,000
Bateman Eichler, Hill Richards Incorporated……………….
15,000Bear, Stearns & Co. Inc……………………………………..
42,000
Sanford C. Bernstein & Co., Inc…………………………….
15,000Birr, Wilson & Co., Inc……………………………………..
6,000
William Blair & Company………………………………….
15,000Blunt Ellis & Loewi Incorporated…………………………..
15,000
Boettcher & Company, Inc………………………………….
15,000J. C. Bradford & Co., Incorporated…………………………
15,000
Brean Murray, Foster Securities Inc………………………...
6,000
Butcher & Singer Inc……………………………………….
15,000
Cable, Howse & Ragen……………………………………..
42,000Carolina Securities Corporation…………………………….
6,000
Cazenove Inc………………………………………………..
6,000
The Chicago Corporation…………………………………...
6,000
Cowen & Co………………………………………………...
15,000Credit Commercial de France………………………………
15,000Dain Bosworth Incorporated………………………………..
15,000Daiwa Securities America Inc………………………………
6,000
D.A. Davidson & Co. Incorporated…………………………
6,000
Deutsche Bank Capital Corporation………………………...
15,000R. G. Dickinson & Co………………………………………
6,000
Dillon, Read & Co. Inc……………………………………..
42,000Doft & Co., Inc……………………………………………...
6,000
Donaldson, Lufkin & Jenrette Securities Corporation……...
42,000Drexel Burnham Lambert Incorporated…………………….
42,000Eberstadt Fleming Inc…………………………….…………
15,000A. G. Edwards & Sons, Inc…………………….…………...
15,000
Eppler, Guerin & Turner, Inc……………………………….
15,000EuroPartners Securities Corporation………………………..
15,000First Albany Corporation……………………………………
6,000
The First Boston Corporation……………………………….
42,000First Manhattan Co………………………………………….
6,000
First Southwest Company…………………………………..
15,000
Furman Selz Mager Dietz & Birney Incorporated………….
15,000
Gruntal & Co., Incorporated………………………………...
15,000Hambrecht & Quist Incorporated…………………………...
42,000Hill Samuel & Co. Limited…………………………………
15,000J. J. B. Hilliard, W. L. Lyons, Inc…………………………..
6,000
Hoare Govett Limited……………………………………….
6,000
Howard, Weil, Labouisse, Friedrichs Incorporated…………
15,000E. F. Hutton & Company Inc………………………………..
42,000Interstate Securities Corporation……………………………
15,000Investment Corporation of Virginia………………………...
6,000
Janney Montgomery Scott Inc………………………………
15,000Johnson, Lane, Space, Smith & Co., Inc……………………
6,000
Johnston, Lemon & Co. Incorporated………………………
6,000
Josephthal & Co. Incorporated……………………………...
15,000Kidder, Peabody & Co. Incorporated……………………….
42,00033

Number ofUnderwriter
SharesKleinwort, Benson Incorporated…………………………
15,000Ladenburg, Thalmann & Co. Inc………………………...
15,000Cyrus J. Lawrence Incorporated…………………………
6,000
Lazard Frères & Co………………………………………
42,000Legg Mason Wood Walker Incorporated………………..
15,000
McDonald & Company…………………………………..
15,000Merrill Lynch, Pierce, Fenner & Smith Incorporated.…...
42,000Montgomery Securities…………………………………..
42,000
Moore & Schley Capital Corporation……………………
6,000
Morgan Grenfell & Co. Limited…………………………
15,000Morgan Keegan & Company, Inc………………………..
6,000
Morgan Stanley & Co. Incorporated……………………..
42,000
Moseley, Hallgarten, Estabrook & Weeden Inc………….
15,000
Needham & Company, Inc……………………………….
6,000
Neuberger & Berman…………………………………….
6,000
W. H. Newbold’s Son & Co., Inc………………………..
6.000
Newhard, Cook & Co. Incorporated……………………..
6,000
The Nikko Securities Co. International, Inc..………….…
6,000
Nomura Securities International, Inc…………………….
6,000
The Ohio Company………………………………………
15,000
Oppenheimer & Co., Inc…………………………………
15,000PaineWebber Incorporated……………………………….
42,000Parker/Hunter Incorporated………………………………
6,000
Pictet & Cie………………………………………………
6,000
Piper, Jaffray & Hopwood Incorporated…………………
15,000Prescott, Ball & Turben, Inc……………………………..
15,000Prudential-Bache Securities Inc………………………….
42,000Rauscher Pierce Refsnes, Inc…………………………….
15,000Raymond, James & Associates, Inc……………………...
6,000
Robertson, Colman & Stephens………………………….
42,000
The Robinson-Humphrey Company, Inc………………...
15,000Rotan Mosle Inc………………………………….………
15,000Rothschild Inc……………………………………………
15,000L. F. Rothschild, Unterberg, Towbin, Inc………………..
42,000R. Rowland & Co., Incorporated………………...………
6,000
Sal. Oppenheim Jr. & Cie………………………………..
6,000
Salomon Brothers Inc…………………………………….
42,000J. Henry Schroder Wagg & Co. Limited…………………
15,000
Seidler Amdec Securities Inc…………………………….
6.000
Shearson Lehman Brothers Inc…………………………..
42,000
Sogen Securities Corporation…………………………….
15,000
Stephens Inc……………………………………………...
15,000Stifel, Nicolaus & Company, Incorporated………………
15,000
Sutro & Co. Incorporated………………………………...
15,000Swergold, Chefitz & Sinsabaugh, Inc……………………
6,000
Swiss Bank Corporation International Securities Inc.…...
15,000Thomson McKinnon Securities Inc……………………...
15,000
Tucker, Anthony & R. L. Day, Inc……………..………..
15,000UBS Securities Inc……………………………………….
15,000Underwood, Neuhaus & Co. Incorporated ………………
15,000
Vereins-und Westbank A.G……………………………...
6,000
Wedbush, Noble, Cooke, Inc…………………………….
6,000
Wertheim & Co., Inc……………………………………..
42,000Wheat, First Securities, Inc………………………………
15,000Dean Witter Reynolds Inc………………………………..
42,000
Yamaichi International (America), Inc…………………..
6,000
Total………………………………………………. 2,795,000

Excluding shares subject to the over-allotment option, each of the Underwriters is to purchase fromthe Company and each of the Selling Stockholders, respectively, that number of shares which bears thesame proportion to the total number of shares to be sold by the Company and the Selling Stockholders as
the total number of shares to be purchased by such Underwriters bears to the total number of shares to bepurchased by all of the Underwriters.
Under the terms and conditions of the Underwriting Agreement, the Underwriters are committed topurchase all the shares offered hereby, if any are purchased.
There has been no previous market for any of the Company’s securities. The major factors
considered by the Company, the Selling Stockholders, and the Representatives in determining the public
offering price of the Common Stock, in addition to prevailing market conditions, were historicalperformance, estimates of the business potential and earnings prospects of the Company, the present stateof the Company’s development, an assessment of the Company’s management, and the consideration of
the above factors in relation to market valuations of comparable companies. Based on the initial public
offering price, and assuming that the Underwriters’ over-allotment option is not exercised, the aggregate
market value of shares outstanding after the offering will be approximately $519,017,373.
The Underwriters propose to offer the shares in part directly to the public at the initial public
offering price set forth on the cover page of this Prospectus and in part to certain securities dealers at suchprice less a concession of $0.75 per share. The Underwriters may allow, and such dealers may reallow, aconcession not in excess of $0.10 per share to certain brokers and dealers. After the shares are released forsale to the public, the public offering price and other selling terms may from time to time be varied by the
Representatives.
The Company has granted the Underwriters an option exercisable for 30 days after the date of thisProspectus to purchase up to an aggregate of 300,000 additional shares of Common Stock to cover overallotments, if any. If the Underwriters exercise their over-allotment option, the Underwriters haveseverally agreed, subject to certain conditions, to purchase approximately the same percentage thereof
that the number of shares to be purchased by each of them as shown in the foregoing table bears to the2,795,000 shares of Common Stock offered hereby. The Underwriters may exercise such option only tocover over-allotments made in connection with the sale of the 2,795,000 shares of the Common Stockoffered hereby.
The Representatives have informed the Company that they do not expect sales to discretionary
accounts by the Underwriters to exceed five percent of the total number of shares of Common Stockoffered by them hereby and that sales to discretionary accounts by the Representatives will be less than
one percent of the total number of shares of Common Stock offered by them hereby.
The Company, and the Selling Stockholders, officers, and directors, holding in the aggregate
approximately 21,070,000 shares of Common Stock, have agreed not to offer, sell, or otherwise disposeof any shares of Common Stock for a period of 120 days after the date of this Prospectus without the priorwritten consent of the Representatives, except that the Company may, without such consent, grant
options, or issue stock upon exercise of outstanding options, pursuant to the Option Plan, and issue stock
pursuant to the Purchase Plan.
The Company and the Selling Stockholders have agreed to indemnify the Underwriters against
certain civil liabilities, including liabilities under the Act.
LEGAL MATTERS
The validity of the shares of Common Stock offered hereby will be passed upon for the Company by
Shidler McBroom Gates & Lucas, Seattle, Washington, and for the Underwriters by Sullivan &Cromwell, Los Angeles, California. Sullivan & Cromwell may rely upon the opinion of Shidler
McBroom Gates & Lucas as to matters of Washington law. Members of Shidler McBroom Gates & Lucas34

beneficially owned 114,000 shares of Common Stock prior to this offering. See “Management—Certain
Transactions” and “Principal and Selling Stockholders.”
EXPERTSThe consolidated financial statements included in this Prospectus, and the related supplemental
schedules included elsewhere in the Registration Statement as of June 30, 1984 and 1985 and for each of
the three years in the period ended June 30, 1985, and the consolidated financial statements as of June 30,
1982 and 1983 and for the year ended June 30, 1982, from which the Selected Consolidated Financial
Data included in this Prospectus have been derived, have been examined by Deloitte Haskins & Sells,
independent public accountants, as stated in their opinions appearing herein and elsewhere in theRegistration Statement. Such consolidated financial statements, supplemental schedules, and Selected
Consolidated Financial Data have been so included in reliance upon such opinions given upon theauthority of that firm as experts in accounting and auditing.
ADDITIONAL INFORMATIONThe Company has filed with the Securities and Exchange Commission, Washington, D.C., a
Registration Statement under the Act, as amended, with respect to the Common Stock offered hereby.
This Prospectus does not contain all of the information set forth in the Registration Statement and theexhibits and schedules thereto. For further information with respect to the Company and the Common
Stock, reference is hereby made to such Registration Statement, exhibits, and schedules, copies of which
may be obtained from the Commission’s principal office in Washington, D.C., upon payment of the feesprescribed by the Commission.

35

OPINION OF INDEPENDENT PUBLIC ACCOUNTANTS
Microsoft Corporation:
We have examined the consolidated balance sheets of Microsoft Corporation and subsidiaries as of June30, 1984 and 1985, and the related consolidated statements of income, stockholders’ equity, and changes
in financial position for each of the three years in the period ended June 30. 1985. Our examinations weremade in accordance with generally accepted auditing standards and, accordingly, included such tests of
the accounting records and such other auditing procedures as we considered necessary in thecircumstances.
In our opinion, such consolidated financial statements present fairly the financial position of Microsoft
Corporation and subsidiaries at June 30, 1984 and 1985 and the results of their operations and the changes
in their financial position for each of the three years in the period ended June 30, 1985, in conformity withgenerally accepted accounting principles applied on a consistent basis.
We have also previously examined, in accordance with generally accepted auditing standards, theconsolidated balance sheets as of June 30, 1982 and 1983 and the related consolidated statements ofincome, stockholders’ equity, and changes in financial position for the year ended June 30, 1982 (none ofwhich are presented herein); and we expressed unqualified opinions on those consolidated financial
statements. In our opinion, the information set forth in the selected financial data for each of the four
years in the period ended June 30, 1985 appearing on page 9 is fairly stated in all material respects inrelation to the consolidated financial statements from which it has been derived.

DELOITTE HASKINS & SELLS
Bellevue, Washington
August 15,1985(January 29, 1986 as to Notes 4 and 9)36

MICROSOFT CORPORATIONCONSOLIDATED BALANCE SHEETSASSETS
December 31,
1985(Unaudited)(In thousands, except share data)

1984

June 30,
1985

Current assets:
Cash and short-term investments$ 3,282
Trade accounts receivable — net of allowance for doubtful
accounts of $1,964, $2,288 and $2,860……………...…………. 23,566
Inventories (Note 2)…………………………………………...….. 9,770
Other (Note 7)………………………………………………...…... 1,329$18,948$38,158

25,273
5,919
1,926

33,8935,730
2,386

52,06680,167

11,1901,808$65,064

12,661
1,610$94,438

LIABILITIES AND STOCKHOLDERS’ EQUITYCurrent liabilities:
Accounts payable……………………………………………...….. $ 4,954 $ 2,497
Customer deposits……………………………………………...…. 3,709
2,757
Royalties and commissions payable………………………………. 1,460
1,315
Deferred income taxes…………………………………………….. 4,108
1,251
Other………………………………………………………………. 2,258
2,804
Total current liabilities……………………………………...…. 16,489
10,624$ 4,533
3,892
3,220
6,872
4,076
22,593

Total current assets……………………………………..….…... 37,947
Property and equipment — net (Note 3)………………………..….…
Other assets………………………………………………………...…

Long-term debt (Note 5)………………………………………..….…

8,076
1,614
$47,637436——

Commitments and contingencies (Notes 4, 6 and 9)
Stockholders’ equity (Note 7):
Convertible Preferred Stock - $.01 par value; shares authorized
and outstanding 500,000; liquidation preference $1,000,000; tobe automatically converted to 1,000,000 shares of Common
Stock upon completion of a public offering of the Company’s
Common Stock…………………………………………………
5
Common Stock — $.001 par value; shares authorized 60,000,000;
issued and outstanding before 1,000,000 shares fromconversion of preferred stock — 21,260,227, 21,533,353 and21,715,113.…………………………………………………......
21
Paid-in capital……………………………………………………... 4,873
Retained earnings…………………………………………...…….. 25,873
Translation adjustment………………………………………….....
(60)

5

5

22
5,101
49,974
(662)

22
5,277
67,092(551)

Total stockholders’ equity…………………………………...… 30,712$47,637

54,440$65,064

71,845$94,438

See accompanying notes.

37

MICROSOFT CORPORATIONCONSOLIDATED STATEMENTS OF INCOME
Six Months
Ended December 31,
1984
1985
(Unaudited)(In thousands, except per share data)

Year Ended June 30,
1983
1984
1985

Net revenues……………………………..…..… $ 50,065
Costs and expenses:
Cost of revenues………………………….…. 15,773
Research and development……………….…. 7,021
Sales and marketing…………………….…… 11,916
General and administrative……………….....
4,698
Total costs and expenses……………….… 39,408
Income from operations…………………….….. 10,657
Non-operating income (loss) (Note 1)……….…
407
Income before income taxes………………….... 11,064
Provision for income taxes (Note 4)……….…... 4,577
Net income………………………..………..….. $ 6,487
Net income per share……………………….….. $.29
Shares used in computing
net income per share………………….…….. 22,681$ 97,479$140,417$ 62,837$ 85,050

22,900
10,66526,027
8,784
68,37629,103(1,073)28,03012,150$ 15,880$.69

30,447
17,10842,512
9,443
99,51040,907
1,936
42,84318,742$ 24,101$ 1.04

15,507
7,414
18,2683,831
45,02017,817402
18,2198,223$ 9,996$.43

18,2708,720
24,4296,980
58,39926,651
2,397
29,048
11,930$ 17,118$.72

22,94723,26023,25323,936

See accompanying notes.

38

MICROSOFT CORPORATIONCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Preferred Stock

SharesCommon Stock

Treasury Stock
Paid-In
Retained
CapitalEarnings
Shares(In thousands, except share data)

AmountSharesAmountBalance, June 30, 1982….. 500,000$521,830,566$22$4,766$ 3,506

Sale of stock to employees..

—

—

1,000

—

—

—

Purchase of treasury stock…
Amortization of deferredcompensation………..….
Net income for year ended
June 30, 1983………...…
Foreign currencytranslation adjustment…..

—

—

—

—

—

—

(997,366)

—

—

—

—

573

—

—

—

—

—

—

—

—

—

—

—

Balance, June 30, 1983…... 500,000

521,831,566

22

Sale of stock to employees..
Retirement of treasury
stock…………………….
Amortization of deferredcompensation…….……..
Net income for year ended
June 30, 1984……..…….
Foreign currency translation
adjustment………………

——

426,027———(997,366)

—

—

—
—

Balance, June 30, 1984…….500,000
Sale of stock principally toemployees……………..... —Amortization of deferredcompensation………..…. —Net income for year ended
June 30, 1985………..…. —Foreign currencytranslation adjustment….. —Balance, June 30, 1985…….500,000
Sale of stock principally toemployees (Unaudited).. —Net income for the six
months ended
December 31, 1985
(Unaudited)………..…… —Foreign currencytranslation adjustment—(Unaudited)…………...
Balance, December 31,
1985 (Unaudited)…...….. 500,000

AmountTranslation
Adjustment

Total
Stockholders’Equity$ 8,299$ (732)

(732)

—

—

573

6,487

—

—

6,487

—

—

—

5,339

9,993

(997,366)

26

—

—

(1)

(732)

—

997,366

—

—

240

—

—

—

—

—

—

15,880

—

—

—

—

5

21,260,227

21—

273,126

—
—

11

11

14,638

—

26

—

(1)

—

—

240

—

—

—

15,880

—

—

—

(71)

(71)

4,873

25,873——(60)

30,712

1

145

—

—

—

—

146

—

—

83

—

—

—

—

83

—

—

24,101———

24,101

—

—

—

—

—

—

—

(602)

(602)

5

21,533,353

22

5,101

49,974

—

—

(662)

54,440—181,760

—

176

—

—

—

—

176

—

—

—

—

17,118———

17,118

—

—

—

—

—

—

—

111

111

$5

21,715,113$22$5,277$67,092——$ (551)$71,845—

See accompanying notes.

39

(73)

$ 11

—
732

MICROSOFT CORPORATIONCONSOLIDATED STATEMENTS OF CHANGES IN FINANCIAL POSITION
Six Months Ended
December 31,
1984
1985
(Unaudited)Year Ended June 30,
1983
1984
1985
(In thousands)

Working capital provided:
Operations:
Net income……………………………… $ 6,487
Depreciation…………………………….. 1,007
Other……………………………………. 1,190$15,880 $24,101
2,068
3,462
(684)
83

$ 9,996
1,423—$17,118
2,403—

Total from operations……………….. 8,684
Common stock issued……………………… —Long-term borrowings……………………..
—Total working capital provided…………. 8,684
Working capital used:
Additions to property and equipment — net
3,230
Reduction of long-term debt………………. —Loans to stockholders — net……………….
(159)
Purchase of treasury stock………………….
732
Translation adjustment……………………..
(11)
Other………………………………………..
245
Total working capital used………………… 4,037
Increase in working capital……………………. $ 4,647

17,264591
848
18,70327,646368—
28,014

11,41943—
11,462

19,521
207—
19,728

5,837
413
534
—
72
341
7,197
$11,506

6,576
436
213
—
602
203
8,030
$19,984

3,531
—
19
—
635
19
4,204
$ 7,258

3,874
—
52
—
(111)
(219)
3,596
$16,132

Changes in elements of working capital:
Current assets – increase (decrease):
Cash and short-term investments………. $ 15
Trade accounts receivable………………. 5,789
Inventories……………………………… 1,341
Other…………………….………………
89
Current liabilities — (increase) decrease….. (2,587)$ 53 $15,666
13,5181,707
5,225(3,851)438
597(7,728)5,865$ 7,460
4,537(2,964)804(2,579)$19,210
8,620
(189)
460
(11,969)

Increase in working capital……………………. $ 4,647$11,506$ 7,258$16,132

See accompanying notes.

40$19,984

MICROSOFT CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1.

SIGNIFICANT ACCOUNTING POLICIESBusiness — The Company’s principal business activity is the design, development and distributionof microcomputer software along with the distribution of related books and hardware peripheral devices.
Principles of Consolidation — The consolidated financial statements include the accounts ofMicrosoft and its wholly-owned subsidiaries. Significant intercompany transactions and balances havebeen eliminated.
Revenue Recognition — Revenue from sales of software and hardware consumer products todistributors or retail dealers is recognized when the product is shipped.
Software products are sold to original equipment manufacturers under license agreements which
generally provide for a commitment fee payable over a minimum commitment period of one to three
years. When the product is accepted, the commitment fee is recognized as revenue ratably over theminimum commitment period or on a per-system or per-copy basis if sales exceed the commitment fee
level. Subsequent to the minimum commitment period, revenue based upon the number of systems
shipped or copies sold is recognized as earned. Commitment fees received prior to product acceptance arerecorded as customer deposits.
Short-term Investments — Short-term investments are carried at cost which approximates market.
Inventories — Inventories are valued at the lower of cost or market. Cost is determined using thefirst-in, first-out method.
Property and Equipment — Property and equipment are stated at cost and depreciated using straightline and declining-balance methods over their estimated useful lives of from 5 to 7 years.
Warranties and Exchanges — The Company warrants certain products against certain defects andhas policies permitting dealers and distributors to exchange products under certain circumstances. The
Company’s policies do not permit return of products for credit or refund. Estimated liabilities forwarranties and exchanges at June 30, 1984 and 1985 and December 31, 1985 were not material.
Software Research and Development Costs — The majority of the Company’s products are developed internally. Costs related to research and development and to production of software product masters
are expensed as incurred. In August 1985, the Financial Accounting Standards Board issued a statement
requiring capitalization of certain costs of producing software product masters beginning in the
Company’s year ending June 30, 1987. Had these new guidelines been applicable to the accompanying
financial statements, income from operations may have been higher than amounts reported by anindeterminable amount.
Cost of revenues include royalties paid to authors of certain software products made under license
agreements. Such royalties, which are based on net revenues were $3,222,000, $2,801,000, and$3,736,000 for the years ended June 30, 1983, 1984 and 1985 and $2,037,000 and $2,684,000 for the six
months ended December 31, 1984 and 1985.
Non-operating income — Non-operating income includes interest income of $407,000, $427,000
and $952,000 for the years ended June 30, 1983, 1984 and 1985 and $402,000 and $1,151,000 for the six
months ended December 31, 1984 and 1985. In addition, in 1984 the Company realized a short-term
capital loss of $1,500,000 from the write-off of the entire value of a minority interest in a closely heldcompany. In 1985 the Company realized a short-term capital gain of $984,000 upon the sale ofmarketable equity securities. During the six months ended December 31, 1985 the Company realized

41

MICROSOFT CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
a foreign currency transaction gain of $1,245,000 resulting from the repayment of debt from certain
international subsidiaries.
Income Taxes — Certain items of income and expense included in the financial statements arereported in different years in the tax returns in accordance with applicable income tax laws. The resulting
difference between the financial statement income tax provision and income taxes currently payable isreported in the financial statements as deferred income taxes. Investment and other tax credits areaccounted for as a reduction of tax expense in the year in which the credits reduce taxes payable (flowthrough method).
Foreign Currency Translation — Assets and liabilities denominated in foreign currencies aretranslated at the exchange rate on the balance sheet date. Revenues, costs, and expenses are translatedusing an average rate. Translation adjustments are shown separately in stockholders’ equity.
Net Income Per Share — Net income per share is computed on the basis of the weighted average
number of common and common equivalent shares outstanding and is adjusted for the assumed
conversion of preferred shares and shares issuable upon exercise of stock options. The computation
assumes the proceeds from the exercise of stock options were used to repurchase common shares at theindependently appraised value of the Company’s common stock in each period. Had the computation
been made assuming that Common Stock issued during the twelve months ended December 31, 1985 wasoutstanding in all periods and assuming that proceeds from the exercise of stock options issued during thetwelve months ended December 31, 1985 were used to repurchase common shares at the price of shares
offered for sale by this Prospectus, net income per share would not have been significantly less than that
presented for each period.
Interim Financial Information — The financial statements at December 31, 1985 and for the six
month periods ended December 31, 1984 and 1985 are unaudited but, in management’s opinion, reflect
all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation.
2.

INVENTORIESInventories at June 30, 1984 and 1985, and at December 31, 1985 were as follows:
June 30,
December 31,
1984
1985
1985
(In thousands)

Finished goods…………………………………………………… $1,507
Raw materials……………………………………………………. 8,263
Total……………………………………………………………… $9,770$3,414
2,505$5,919$3,3982,332$5,730MICROSOFT CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3.

PROPERTY AND EQUIPMENT
Property and equipment at June 30, 1984 and 1985, and at December 31, 1985 were as follows:
June 30,
December 31,
1984
1985
1985
(In thousands)

Computer equipment……………………………………….….$7,007
Office furniture and equipment……………………………..... 2,899
Leasehold improvements…………………………………..…. 1,658
11,564
Less accumulated depreciation…………………………..…… 3,488
Property and equipment — net…………………………..…… $8,076

4.

$11,574
4,306
2,260
18,1406,950$11,190$14,241
5,143
2,630
22,014
9,353$12,661

INCOME TAXESThe provision for income taxes is composed of:1983

Current………………………………………………………..……... $3,325
Deferred……………………………………………………………... 1,252
Total………………………………………………………….……… $4,577

Year Ended June 30,
1984
1985
(In thousands)$11,549
601$12,150$17,363
1,379$18,742

The provision for deferred income taxes is composed of:Cash basis tax accounting…………………………………………… $ 35 $ 2,270 $ 2,309
Deferred compensation……………………………………………… (264)
(111)
(38)
Inventory adjustment………………………………………………... —
(850)
(714)
DISC…………………………………………….…………………... 1,323
(12)
(282)
Other-net…………………………….………...…………………….. 158
(696)
104
Total………………………………………….……………………… $1,252 $ 601 $ 1,379

43MICROSOFT CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The Company’s effective tax rate differs from the federal rate as follows:
1983

AmountFederal income taxes at statutory rate
$5,090State income taxes net of federal tax
benefit………………………….…… —Unrealized tax benefit of foreign
operating losses.………………….…
251
Unrealized (realized) tax benefit ofcapital loss carryforward…………… —DISC/IFSC benefit……………………… —Tax credits………………………….…… (846)Other-net……………………………...…
82
Total………………………………….…. $4,577

1984

%of
Pre-Tax
Income

46.0%

1985

%of
Pre-Tax
AmountIncome(In thousands)$12,893

Amount%of
Pre-Tax
Income46.0%$19,708

46.0%

—

500

1.8

1,194

2.8

2.3

534

1.9

516

1.2

—
—
(7.6)
.7
41.4%

690
(1,754)(1,368)655$12,150

2.5
(6.3)
(4.9)
2.3
43.3%

(453)
(1,247)(2,007)
1,031$18,742

(1.1)
(2.9)
(4.7)
2.4
43.7%

In 1984 the Company reversed Domestic International Sales Corporation (DISC) deferred taxes as aresult of federal legislation to permanently exempt certain DISC earnings from taxation.
At June 30, 1985 the Company had capital loss carryforwards of $516,000 which expire in 1989 andunused foreign operating loss carryforwards of $2,906,000, available to offest future foreign taxable
income, which expire as follows: 1988, $354,000; 1989, $602,000; 1990, $591,000; 1991, $133,000;
1992, $380,000; indefinitely, $846,000.
In the course of a current examination of the years ended June 30, 1983 and 1984 by the Internal
Revenue Service, a field agent has proposed that the Company is subject to the personal holding company(“PHC”) tax. The PHC penalty tax applies to a corporation that meets two tests: (1) more than 50% of theoutstanding stock is owned by five or fewer individuals, and (2) at least 60% of its adjusted ordinary
gross income, as defined in Section 543 of the Internal Revenue Code, is from passive sources such as
interest, dividends, rents, and royalties. The law was designed to discourage the accumulation of passive
income by closely-held corporations and is generally not applied to active operating corporations.
However, in September 1984 the Internal Revenue Service issued a private letter ruling holding that
income from license fees and maintenance fees received by a developer of custom software which it
licensed, relying on trademark and trade secret protection, to a limited number of large companies andgovernmental agencies was “personal holding company income” under Section 543 of the Internal
Revenue Code. The Company meets the stock ownership requirement and is expected to continue to meetthat test after the offering. However, the Company believes that its business significantly differs from thecorporation discussed in the private letter ruling and that its retail sales of mass produced packaged
software products are sales of tangible personal property and should not be classified as PHC income.
The PHC tax is 50% of after-tax income and through December 31, 1985 could be as much as
approximately $30,000,000 plus interest. At its option, a corporation subject to the PHC tax may declare a“deficiency dividend” to its stockholders of record at the time such a dividend is declared in an amountequal to the corporation’s undistributed PHC income. For the Company this could be as much as
approximately $60,000,000 as of December 31, 1985. The payment of a deficiency dividend avoids a
PHC tax to the corporation (but not the related interest) but is taxable to the shareholders. If a PHC tax

44

MICROSOFT CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
were to be assessed and the Company elected to pay the tax, the payment of tax would be recorded as acharge to operations and would reduce net income accordingly. If a PHC tax were to be assessed and theCompany elected to declare a deficiency dividend, retained earnings would be reduced by the amount ofsuch a dividend.
The 1985 Tax Reform Bill passed by the House of Representatives in December 1985 and currently
under consideration in the Senate, contains a safe-harbor provision specifically for software royalty
income. Congress has amended the PHC tax provisions at least 20 times, generally to alleviate harshtreatment of an active industry that happened to fall within the mechanical test of the PHC tax. In a few
instances, the amendment has been retroactive. Retroactive enactment of the computer software provision
is actively supported by some members of Congress. If passed, the proposed change would remove theCompany from personal holding company status. Regardless of whether corrective legislation is passed
and regardless of whether such legislation is retroactive, the Company believes that its retail sales are
greater than 40% of adjusted ordinary gross income for all significant periods through December 31, 1985
and that such sales are not PHC income, and intends to vigorously contest any PHC tax assessment.
Although management and counsel presently believe that there is a small risk that the Company
might have to either pay the PHC tax or declare a deficiency dividend, they believe that it is more likely
than not that neither payment of a material tax nor a material deficiency dividend will be required.
Because the total amount of any PHC tax that might be assessed could vary significantly based upon thespecific year for which such an assessment might occur and other facts and circumstances and because
management and counsel presently believe that it is more likely than not that neither a material paymentof a PHC tax nor a material deficiency dividend will be required, management has not formulated specificintentions as to how the Company will proceed in the event such a tax is assessed.
5.

LONG-TERM DEBT
June 30,
1984
1985(In thousands)

12% Long-term note payable………………………………………………
Less current portion………………………………………………………...
Total………………………………………………………………………...

$705
269
$436

$650
650
—

The current portion of long-term debt is included in other current liabilities in the financial
statements. At December 31, 1985 the Company had no long-term debt.
6.

LEASESIn July 1985, the Company entered a lease for a new corporate campus. The Company will occupy
the facility upon completion of construction scheduled for the Spring of 1986. The noncancelable
operating lease expires in 2001 with renewal options through 2011. The Company also leases various
other facilities and equipment under operating leases that expire through 1988. Rental expense wasapproximately $926,000, $2,373,000 and $3,012,000 for the years ended June 30, 1983, 1984 and 1985
and $1,210,000 and $1,925,000 for the six months ended December 31, 1984 and 1985.
Minimum lease commitments including the new corporate campus, for years subsequent to June 30,
1985, are as follows: 1986, $4,329,000; 1987, $4,244,000; 1988, $3,900,000; 1989, $3,383,000; 1990,$3,485,000; thereafter, $55,874,000.

MICROSOFT CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
7.

STOCKHOLDERS’ EQUITY

Authorized Capital and Common Stock Split — During 1984, the number of shares of authorized$.001 par value common stock was increased from 20,000,000 to 60,000,000 and a 2 for 1 common stock
split was effected in the form of a stock dividend. All share and per share information has been restated togive effect to the stock split.
Preferred Stock — Preferred stock is convertible into 1,000,000 shares of common stock (subject toadjustment in certain events) at the option of the holder, or automatically upon sale of the Company’scommon stock in a public offering in which aggregate cash proceeds are at least $5,000,000. The
Company has reserved 1,000,000 shares of common stock for conversion. Preferred stock is redeemablein whole, but not in part, at the option of the Company at any time after receipt of written consent fromthe holders of two-thirds of the then outstanding preferred stock or at any time after May 1, 1986. The
redemption price is $2 per share plus declared but unpaid dividends (none to date) to the date ofredemption. In the event of voluntary or involuntary liquidation, holders of preferred stock are entitled to$2 per share plus declared but unpaid dividends.
Preferred shares have the same voting rights as common stock and are entitled to dividends as
declared by the Board of Directors. No dividends may be paid on common stock unless the preferredstock, at the same time or prior thereto, receives a dividend of an equal or larger amount per share.
Employee Stock Purchases — In 1982, certain shares of common stock were sold to employees atprices below fair value as independently appraised. The excess was charged to compensation during theperiod that related services were performed. At June 30,1984 unamortized deferred compensation expenseof $83,000 was recorded as an offset to paid-in-capital. Such deferred compensation was fully amortized
during the year ended June 30, 1985. Other assets included 7% loans to stockholders of $746,000 and$736,000 at June 30, 1984 and 1985 and $757,000 at December 31, 1985 originally made to employees toenable them to pay personal income taxes arising from this transaction. Stock purchase agreements withthese employees provide the Company with the right of first refusal to repurchase employee’s shares and,in 1983, 997,366 shares of common stock were purchased from terminated employees.
During the years ended June 30, 1984 and 1985 and the six months ended December 31, 1985,
353,335, 58,335 and 8,000 shares of common stock were issued to employees at independently appraised
fair values for 9% notes receivable of $540,000, $175,000 and $44,000. Such notes have been recorded asa reduction of paid-in-capital. Payments under these notes, due from 1991 to 1993, will be credited topaid-in-capital as received.
Employee Stock Purchase Plan — In January 1986, the Company established an employee stock
purchase plan for all employees. Employees may contribute up to 10% of their compensation to purchase
the Company’s common stock at fair market value. The Plan will commence in July 1986 and terminate
December 1990. The Company has reserved 300,000 shares of common stock for the plan.
Stock Option Plan — The Company has a stock option plan for officers and key employees which
provides for nonqualified and incentive options. The Board of Directors determines the option price (notto be less than fair market value for incentive options) at the date of grant. The options generally expire
five years from the date of grant and are exercisable over the period stated in each option.

46

MICROSOFT CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Reserved
SharesBalance, June 30, 1982……………………………………...….. 3,020,000
Granted…………………………………………………...…..
—
Exercised………………………………………………...…...
(1,000)
Expired……………………………………………….…...….
—

Outstanding Options
Price Per
NumberShare

900,598
532,000(1,000)(54,342)

$
$
$
$

.475
1.50
.475
.475

Balance, June 30, 1983…………………………………..…...… 3,019,000 1,377,256
Granted…………………………………………………….....
—
733,615
Exercised…………………………………………….……..... (72,692)(72,692)
Expired…………………………………………….…...…….
—(109,464)$.475–$1.50$1.50–$3.00$.475–$l.50

Balance, June 30, 1984…………………………………...…….. 2,946,308 1,928,715
Granted…………………………………………………...…..
—
652,715
Exercised………………………………………….……...….. (214,153) (214,153)
Expired…………………………………………….……...….
—(219,726)$.475–$3.00$
3.00$.475–$3.00$.475–$3.00

Balance, June 30, 1985
2,732,155 2,147,551
Additional shares reserved ………………………….….…… 200,000—
Granted…………………………………………………...…..
—
848,865
Exercised…………………………………………………….. (160,398) (160,398)
Expired…………………………………………………....….
—(168,157)$.475–$3.00

Balance, December 31, 1985………………………………...…. 2,771,757$.475–$5.50

2,667,861$3.00–$5.50$.475–$3.00$.475–$5.50

Of the options granted during the six months ended December 31, 1985, 150,000 were nonqualified
options. All other options granted were incentive options.
At December 31, 1985, options for 547,118 shares were exercisable and 103,896 shares wereavailable for future grants under the Plan.

47

MICROSOFT CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8.

FOREIGN SALES AND OPERATIONS
UnitedStatesYear ended June 30, 1983:
Net revenues:
United States………………………………. $ 39,944
International………………………………..
9,635
Total……………………………………….. $ 49,579

Foreign
Subsidiaries
Eliminations(In thousands)

$
$

—
637
637

Income from operations……………………… $ 11,289$

Identifiable assets…………………………….. $ 24,556
Year ended June 30, 1984:
Net revenues:
United States………………………………. $ 75,576International………………………………..
22,469Total……………………………………….. $ 98,045$

Consolidated

$

—
(151)
(151)

$ 39,944$ 10,121$ 50,065

(552)

$

(80)

$ 10,657

$

281

$

(509)

$ 24,328

$
$

—
8,555
8,555

$ (7,572)(1,549)$ (9,121)$ 68,004
29,475$ 97,479

Income from operations……………………… $ 29,204$(1,169)$1,068$ 29,103

Identifiable assets……………………………. $ 49,093

$

8,152

$ (9,608)$ 47,637

Year ended June 30, 1985:
Net revenues:
United States………………………………. $109,612
International………………………………..
27,972
Total……………………………………….. $137,584$—
19,745$ 19,745$ (13,895)(3,017)$ (16,912)$ 95,717
44,700$140,417

Income from operations……………………… $ 42,937

$

(378)

$ (1,652)$ 40,907

Identifiable assets…………………………….. $ 71,163$ 12,119$ (18,218)$ 65,064

Cost of revenues includes commissions of $2,090,000, $4,377,000 and $5,179,000 during the years
ended June 30, 1983, 1984 and 1985 and $2,544,000 and $2,453,000 for the six months ended December
31, 1984 and 1985 paid to a foreign company whose major stockholder is a former director of theCompany. The Company is in the process of terminating its relationship with this foreign company.
9.

SUBSEQUENT EVENT

Subsequent to December 31, 1985 Microsoft was served with a summons and complaint in an actioncommenced by Seattle Computer Products, Inc. (“SCP”) in a Washington state court. This action arises
out of an agreement entered into in 1981 under which SCP sold to Microsoft SCP’s rights in a disk
operating system which Microsoft developed into MS-DOS. The complaint, which has not yet been filedwith the court, seeks the following relief: (i) a judicial declaration that under the agreement SCP has an
assignable, perpetual, royalty-free worldwide license from Microsoft for MS-DOS in its current andfuture versions; (ii) an injunction against Microsoft prohibiting alleged interference with SCP’s attempts

48

MICROSOFT CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
to sell its business and requiring Microsoft to honor SCP’s interpretation of the agreement; and, in thealternative, (iii) judgment against Microsoft for damages “believed to exceed $20,000,000” or$60,000,000 when trebled or a rescission of the agreement, a return of the rights granted thereunder, andaccounting for the payment to SCP of all revenues received from Microsoft’s marketing of MS-DOS. The
Company believes that SCP’s interpretation of the agreement is erroneous and intends to vigorously
defend this action. In the opinion of the Company, were SCP to prevail on its requested declaratory or
injunctive relief (see items (i) and (ii) above), such a result would not have a material adverse effect on
the Company’s financial condition or results of operations. Although the outcome of litigation can neverbe predicted with certainty, the Company further believes that it is unlikely that SCP could obtain therelief sought with respect to damages or rescission of the contract (see item (iii) above).

The following trademarks are used in this Prospectus:
APPLE is a registered trademark of, and Macintosh is a trademark licensed to Apple Computer, Inc.
AT&T is a registered trademark of American Telephone & Telegraph Co.
COMPAQ is a registered trademark of COMPAQ Computer Corp.
COMPUSERVE is a registered trademark of Compuserve Corporation.
CP / M is a registered trademark of Digital Research Inc.
DEC is a registered trademark of Digital Equipment Corporation.
DOW JONES NEWS/RETRIEVAL is a registered trademark of Dow Jones & Company.
IBM is a registered trademark of International Business Machines Corporation.
INTEL is a registered trademark of Intel Corporation.
LOTUS and 1-2-3 are registered trademarks of Lotus Development Corporation.
MICRORIM is a registered trademark of Microrim, Inc.
MICROSOFT, MS-DOS, MSX-DOS, MSX, XENIX, GW-BASIC, RAMCARD, SOFTCARD and
MULTIPLAN are registered trademarks of Microsoft Corporation.
MITSUBISHI is a registered trademark of Mitsubishi Electric Corporation.
NEWSNET is a registered trademark of NewsNet, Inc.
NEC is a registered trademark of NEC Corporation.
OLIVETTI is a registered trademark of Ing. C. Olivetti.
PHILIPS is a registered trademark of Philips International B.V.
Rbase 5000 is a trademark of Microrim, Inc.
TANDY is a registered trademark of Tandy Corporation.
TRIUMPH is a registered trademark of Triumph Adler AG.
UNIX is a registered trademark of AT&T Information Systems Inc.
ZENITH is a registered trademark of Zenith Radio Corporation.
ZILOG and Z-80 are registered trademarks of Zilog, Inc.

50

No dealer, salesman, or other person has beenauthorized to give any information or to make any
representation not contained in this Prospectus, and, if
given or made, such information or representations
must not be relied upon as having been authorized by
the Company, the Selling Stockholders, or the Underwriters. Neither the delivery of this Prospectus nor any
sale made hereunder shall, under any circumstances,
create any implication that there has been no change in
the affairs of the Company since the date hereof. This
Prospectus does not constitute an offer to sell or asolicitation of an offer to buy any securities other than
the registered securities to which it relates, or an offer
to or solicitation of any person in any jurisdiction inwhich such offer or solicitation is not authorized, or inwhich the person making such offer or solicitation is
not qualified to do so, or to any person to whom it isunlawful to make such an offer or solicitation.

2,795,000 Shares

Microsoft
Corporation
Common Stock

Until June 11, 1986 (90 days after the date of thisProspectus) all dealers effecting transactions in theregistered securities, whether or not participating inthis distribution, may be required to deliver a Prospectus. This is in addition to the obligation of dealers
to deliver a Prospectus when acting as underwriters
and with respect to their unsold allotments or subscriptions.

——————————————

Goldman, Sachs & Co.
Alex. Brown & Sons
Incorporated

51

52