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The following is an excerpt from a 10-K405 SEC Filing, filed by VISIO CORP on 12/29/1999.
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VISIO CORP - 10-K405 - 19991229 - RESULTS_OF_OPERATIONS

Results of Operations

On September 14, 1999, we entered into an Agreement and Plan of Reorganization with Microsoft Corporation and MovieSub, Inc., a wholly owned subsidiary of Microsoft. Under the terms of the agreement, MovieSub, Inc. will merge with us, we will become a wholly owned subsidiary of Microsoft, and each outstanding share of our common stock will be converted into the right to receive 0.45 of a share of Microsoft common stock. On December 13, 1999, our shareholders approved the proposed merger. The merger is subject to antitrust laws, including the reporting and waiting provisions of the Hart-Scott-Rodino Antitrust Improvements Act of 1976. In late September, we and Microsoft made the required premerger notification filings with the Federal Trade Commission and the Antitrust Division of the Department of Justice. On October 29, 1999, the Antitrust Division requested additional information and documents from us and from Microsoft. The requests extended the waiting period under the Hart- Scott-Rodino Act for a period ending 20 days after both parties have filed a proper response. Both companies have filed responses to the requests and are awaiting further action, if any, from the Antitrust Division. Although we currently expect the merger to close in January 2000, the closing could be delayed due to further extension of the waiting period under the Hart-Scott- Rodino Act or other action by the Antitrust Division. Failure to complete the merger could have a material adverse effect on our financial condition and results of operations. For additional information about some of the potential adverse effects, please see "Certain Risk Factors That May Impact Future Results of Operations" beginning on page 26 of this annual report.

In March 1998, we released IntelliCAD, an Autodesk AutoCAD-compatible software product utilizing an engine that is distinct from the Visio engine and employing DWG as its native file format. In July 1999, we granted a royalty- free, perpetual license for the IntelliCAD source code to The IntelliCAD Technology Consortium, a nonprofit corporation established for the purpose of licensing and coordinating broad future development of the IntelliCAD platform. Though we have incorporated portions of the IntelliCAD technology into Visio Technical, we do not currently intend to offer IntelliCAD as a Visio product.

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Revenues

In fiscal 1999, we adopted Statement of Position ("SOP") 97-2, "Software Revenue Recognition" as amended by SOP 98-4 and SOP 98-9. SOP 97-2 supersedes SOP 91-1, the former literature on software revenue recognition. The adoption of this statement did not have a material impact on our financial position or results of operations.

Revenues include fees from the license of software products and maintenance and support contracts, net of reserves for estimated future returns and net of deferrals for revenues attributable to free upgrade rights. License revenues are derived from packaged software products, volume licenses and certain OEM arrangements. Maintenance and support contracts are deferred and recognized in accordance with SOP 97-2. We periodically upgrade our products. Revenues from upgrades are cyclical and are typically highest in the periods of and immediately following an upgrade. We released significant upgrades to Visio Standard in August 1999, to Visio Technical in September 1999, to Visio Professional in November 1999 and to Visio Enterprise in December 1999. Included in upgrade revenues are revenues from "cross-grades" whereby customers purchase upgrades to move from one of our products to another. Our average selling price per unit is typically higher on sales of new units of packaged products than sales of upgrades, volume licenses or OEM arrangements. Of our primary products, Visio Professional, Visio Technical and Visio Enterprise have higher average selling prices than does Visio Standard. The average selling price of IntelliCAD was also higher than that of Visio Standard. Volume discounts are generally granted on products sold through the Volume Licensing channel.

In March 1999, we increased the prices of all of our primary products sold through the Packaged Product and Direct channels in all regions except Japan. In April 1999, we increased the prices of our Visio Technical and Visio Professional products sold through the Packaged Product and Direct channels in Japan, the largest source of revenues in the Rest of World region. Since March 1999, we have been phasing in price increases on volume licenses as they come up for renewal.

We believe that revenue growth in fiscal 1999 was negatively impacted by customers deferring product purchases in both the Volume Licensing and Packaged Product channels in anticipation of our pending merger with Microsoft which was announced on September 15, 1999. We believe that many customers who also have licensing agreements with Microsoft chose to delay purchases of Visio products due to the announcement of the acquisition. To a lesser extent, results were impacted by customers deferring purchases of information technology products ahead of the upgrade of Visio Professional and Visio Enterprise, which were released in the first quarter of fiscal 2000.

Business Segments

Set forth in the following table are revenues by business segment with the corresponding percentage of total revenues and the year-to-year percentage growth for the fiscal periods indicated:

                                       Fiscal Year Ended September 30,
                         ------------------------------------------------------------
                                    %               %     %                %     %
                           1997   Total   1998    Total Growth   1999    Total Growth
                         -------- ----- --------- ----- ------ --------- ----- ------
                                                (in thousands)
Revenues:
  Business Diagramming.. $ 45,757   45% $  47,524   29%    4%  $  55,284   27%   16%
  Technical Drawing.....   29,916   30     38,108   23    27      37,218   19    (2)
  IT Design and
   Documentation........   25,102   25     80,363   48   220     107,510   54    34
                         --------  ---  ---------  ---   ---   ---------  ---   ---
    Total revenues...... $100,775  100% $ 165,995  100%   65%  $ 200,012  100%   20%
                         ========  ===  =========  ===   ===   =========  ===   ===

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We have three reportable business segments: Business Diagramming, Technical Drawing and IT Design and Documentation. The core product of the Business Diagramming segment is Visio Standard. The core products of the Technical Drawing segment are Visio Technical and IntelliCAD. Visio Professional and Visio Enterprise are the core products of the IT Design and Documentation segment, which also includes Visio Network Equipment. See Note 7 of our financial statements on page 50 of this annual report.

The increase in Business Diagramming revenues in fiscal 1998 compared to fiscal 1997 was attributable to an increase in upgrade revenues due to the version 5.0 upgrade released in August 1997. Revenues from new licenses were flat in fiscal 1998 compared to fiscal 1997. The increase in Business Diagramming revenues in fiscal 1999 compared to fiscal 1998 was primarily attributable to an increase in revenues from the sale of volume license agreements and an increase in upgrade revenues due to the Visio 2000 Standard Edition, released in August 1999. A price increase implemented in March 1999 also contributed to the growth in revenues in fiscal 1999. This increase was partially offset by a decrease in unit volumes of packaged products. The overall average selling prices of products in the Business Diagramming segment decreased in fiscal 1999 compared to fiscal 1998 as a result of more units being sold at a discount under volume license agreements. Revenue growth in fiscal 1999 was also positively impacted by the license of technology to Microsoft for $1.5 million. In addition, we believe that in fiscal 1998 and 1999, growth in the Business Diagramming segment was negatively impacted by Visio Professional to the extent that customers such as IT professionals who may otherwise have purchased Visio Standard chose Visio Professional instead for its added features and content.

The increase in Technical Drawing revenues in fiscal 1998 compared to fiscal 1997 was attributable to an increase in new license volume, upgrade volume and the release of IntelliCAD in March 1998. Average selling prices for the Technical Drawing segment in fiscal 1998 increased slightly from fiscal 1997 due to a higher percentage of revenues attributable to new licenses rather than upgrades. This increase in average selling prices in fiscal 1998 was offset by a higher percentage of revenues sold through the Volume Licensing channel. The decrease in Technical Drawing revenues in fiscal 1999 compared to fiscal 1998 was primarily due to declines in unit volumes of the IntelliCAD product and a decrease in unit volumes of packaged products. Revenues from maintenance contracts were flat in fiscal 1999 compared to fiscal 1998. Overall average selling prices of products in the Technical Drawing segment increased due to a price increase implemented in March 1999. In addition, maintenance revenues remained flat while at the same time the unit volumes of new licenses sold in fiscal 1999 compared to fiscal 1998 decreased. We believe that in fiscal 1998 and 1999 revenue growth in the Technical Drawing segment was negatively impacted by Visio Professional. Prior to the release of Visio Professional, Visio Technical was marketed to IT professionals as a solution for network diagramming.

Visio Professional, our first significant product in the IT Design and Documentation segment, significantly impacted the revenue mix between product groups. Since Visio Professional was introduced in the second quarter of fiscal 1997, sales of that product have grown as the product has been accepted as a viable solution for IT professionals in the design and documentation of their networks, databases, software applications and web sites. Also contributing to the growth of Visio Professional has been the growth of the IT design and documentation market as a whole. The increase in IT Design and Documentation revenues during fiscal 1999 compared to fiscal 1998 was attributable to increased Visio Professional revenues from the sale of volume license agreements and from the sale of packaged products. Visio Enterprise, introduced in November 1998, also contributed significantly to revenue growth in the IT Design and Documentation segment. Average selling prices of Visio Professional decreased in fiscal 1999 compared to fiscal 1998 as a result of more units being sold at a discount under volume license agreements. This decrease in average selling prices of Visio Professional was partially offset by the price increase implemented in March 1999. As noted above, we believe that revenues in the IT Design and Documentation segment were negatively impacted in the fourth quarter of fiscal 1999 by customers deferring purchases of information technology products until after the release of Visio 2000 Professional Edition and Visio 2000 Enterprise Edition, which occurred in the first quarter of fiscal 2000.

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Sales Channels

Set forth in the following table are revenues by sales channel with the corresponding percentage of total revenues and the year-to-year percentage growth for the fiscal periods indicated:

                                  Fiscal Year Ended September 30,
                     ----------------------------------------------------------
                                %              %     %               %     %
                       1997   Total   1998   Total Growth   1999   Total Growth
                     -------- ----- -------- ----- ------ -------- ----- ------
                                           (in thousands)
Revenues:
  Packaged Product.. $ 76,022   75% $115,253   69%   52%  $116,076   58%    1%
  Direct............    6,819    7    10,966    7    61      7,701    4   (30)
  Volume Licensing..   17,046   17    39,343   24   131     74,617   37    90
  OEM...............      888    1       433   --   (51)     1,618    1   274
                     --------  ---  --------  ---   ---   --------  ---   ---
    Total revenues.. $100,775  100% $165,995  100%   65%  $200,012  100%   20%
                     ========  ===  ========  ===   ===   ========  ===   ===

We classify our revenues into four sales channels: "Packaged Product," "Direct," "Volume Licensing," and "OEM." Packaged Product revenues represent sales of packaged products through national distributors and corporate, value added, retail and mail order resellers. Direct revenues generally represent our sales of packaged products directly to end users responding to advertising or marketing promotions. Volume Licensing revenues are derived from volume licenses which are generally administered through corporate resellers after our sales staff has negotiated the sale. The sales cycle for a volume license can extend up to 24 months on significant volume licenses as organizations can require extensive time to evaluate and consider a large-scale implementation. Volume Licensing revenues usually do not include any significant amount of packaged goods, but do include maintenance and support revenues which are priced separately and recognized in accordance with SOP 97-2. OEM revenues include licenses of Visio products to hardware and software manufacturers for bundling arrangements. OEM revenues include packaged product sales, as well as royalty payments with no associated product costs.

Growth during fiscal 1998 compared to fiscal 1997 in both the Packaged Product and Direct channels was primarily driven by the growth of the IT Design and Documentation product group revenues as well as revenues from the version 5.0 upgrade in August 1997. Revenues in the Packaged Product channel were flat and revenues in the Direct channel decreased significantly in fiscal 1999 compared to fiscal 1998. We believe both the Packaged Product and Direct channels were negatively impacted due to an industry wide shift of corporate software customers buying through the Volume Licensing channel rather than through the Packaged Product or Direct channels. In addition, the Direct channel was weaker in fiscal 1999 compared to fiscal 1998 due to the timing of the product upgrade cycle. We released our most recent upgrades for Visio Standard and Visio Technical late in the fourth quarter of fiscal 1999 and as such, these upgrades had very little impact on Direct channel revenues in fiscal 1999 compared to fiscal 1998.

In fiscal 1998 we began making significant investments in our corporate sales force and Volume Licensing programs. This drove the significant growth in the Volume Licensing channel during fiscal 1998 compared to fiscal 1997. In fiscal 1999, we continued to invest in our corporate sales force and Volume Licensing programs as we increased our corporate sales staff from 70 at September 30, 1998 to 106 at September 30, 1999. We expect to hire additional corporate sales staff in fiscal 2000 and therefore expect revenues from Volume Licensing to increase as a percentage of total revenues.

OEM revenues in fiscal 1999 increased compared to fiscal 1998 primarily due to an OEM agreement with Microsoft in the Business Diagramming segment.

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Geographies

Set forth in the following table are revenues by geography with the corresponding percentage of total revenues and the year-to-year percentage growth for the fiscal periods indicated:

                                  Fiscal Year Ended September 30,
                     ----------------------------------------------------------
                                %              %     %               %     %
                       1997   Total   1998   Total Growth   1999   Total Growth
                     -------- ----- -------- ----- ------ -------- ----- ------
                                           (in thousands)
Revenues:
  North America..... $ 65,238   65% $ 98,735   59%   51%  $121,796   61%   23%
  Europe............   22,199   22    41,210   25    86     51,648   26    25
  Rest of World.....   13,338   13    26,050   16    95     26,568   13     2
                     --------  ---  --------  ---   ---   --------  ---   ---
    Total revenues.. $100,775  100% $165,995  100%   65%  $200,012  100%   20%
                     ========  ===  ========  ===   ===   ========  ===   ===

The increase in revenues in all regions in fiscal 1998 compared to fiscal 1997 was primarily attributable to the growth of the IT Design and Documentation segment, the upgrade to version 5.0 and the increase in Volume Licensing. In addition, continued investment in international markets, including localized products, sales offices and staffing, also contributed to the growth of international revenues.

The increase in revenues in North America and Europe in fiscal 1999 compared to fiscal 1998 was primarily due to the contribution of the Visio Enterprise product that was released in November 1998, an increase in revenues from the sale of volume license agreements and our price increase in March 1999. In addition, the release of significant upgrades for Visio Standard in August 1999 and for Visio Technical in September 1999, also contributed to the revenue increase in North America. The increase in revenues in North America and Europe in fiscal 1999 compared to fiscal 1998 was partially offset by decreased revenues from the IntelliCAD product. Revenues in the Rest of World region increased slightly in fiscal 1999 compared to fiscal 1998 due to growth in the IT Design and Documentation products. This growth was partially offset by decreased revenues from the Technical Drawing segment. We believe the percentage of revenues from international regions will increase as new versions of our products are released internationally.

The growth in Rest of World in fiscal 1998 and fiscal 1999 was partially offset by general weakened economic conditions and foreign currency devaluations in Japan and Southeast Asia. These economic and currency conditions may continue to negatively impact revenues and operating results in the Rest of World region in upcoming periods.

Our operating results are affected by foreign exchange rates. Approximately 19%, 30% and 31% of our revenues were collected in foreign currencies during fiscal 1997, 1998 and 1999, respectively. The impact on operating income due to exchange rate fluctuation is partially mitigated as most of our international production costs and operating expenses are incurred in foreign currencies as well. Therefore, the net impact of exchange rate fluctuations on income from operations is less than the impact on revenues.

Cost of Revenues

                                          Fiscal Year Ended September 30,
                                       ----------------------------------------
                                        1997     1998    Change  1999    Change
                                       -------  -------  ------ -------  ------
                                                  (in thousands)
Cost of revenues...................... $10,682  $15,132    42%  $17,795    18%
Percentage of revenues................      11%       9%              9%

Cost of revenues includes both product and period costs. These costs vary by channel and business segment. Product costs consist primarily of documentation, packaging, media duplication, assembly and material management costs. Period costs consist primarily of royalties, technical support costs, capitalized technology amortization, inventory valuation adjustments and costs related to our manufacturing personnel.

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Most of our product costs are associated with the Packaged Product and Direct channels, the majority of which are derived from sales of packaged products. Revenues from the Volume Licensing channel have the lowest product cost because they generally do not include any substantial amount of packaged goods. In addition, period costs are higher as a percentage of revenues for the Technical Drawing segment than for the other two business segments due to support costs for the IntelliCAD product and capitalized technology amortization.

The decrease in cost of revenues as a percentage of revenues in fiscal 1998 compared to fiscal 1997 primarily resulted from increased use of lower cost CD- ROM media and other raw material cost reductions, an increase in the percentage of revenues from the Technical Drawing and IT Design and Documentation segments, which generally have lower standard product costs as a percentage of revenues than the Business Diagramming products, and increased Volume Licensing revenues, which have little or no standard product costs. These decreases were partially offset by increased royalty costs for licensed technology, including Visual Basic for Applications from Microsoft, and increased amortization costs of capitalized technologies.

Cost of revenues as a percentage of revenues in fiscal 1999 remained flat compared to fiscal 1998. Nonetheless, the mix of significant components within cost of revenues has changed. The increase in Volume Licensing revenues as a percentage of total revenues in fiscal 1999 compared to fiscal 1998 has caused product costs as a percentage of revenues to decrease significantly. In addition, we successfully renegotiated our most significant royalty agreement in fiscal 1999 thereby lowering our overall royalty costs in fiscal 1999 compared to fiscal 1998. The decrease in product and royalty costs was offset by increased technical support costs for supporting the IntelliCAD and Visio Enterprise products, an increase in the amortization of capitalized technologies, an increase in inventory reserves and an increase in our manufacturing personnel. We expect cost of revenues to decrease as a percentage of revenues over time as revenues from the Volume Licensing channel grow.

Research and Development

                                           Fiscal Year Ended September 30,
                                        ----------------------------------------
                                         1997     1998    Change  1999    Change
                                        -------  -------  ------ -------  ------
                                                   (in thousands)
Research and development............... $16,073  $27,257    70%  $34,777    28%
Percentage of revenues.................      16%      16%             17%

Research and development expenses consist primarily of personnel, contract services, occupancy and equipment costs required to conduct our product development efforts. Product development includes product engineering, documentation development, localization, usability testing, quality assurance and advanced research and development costs. Product localization costs and lump sum payments for technology are capitalized and amortized to development generally over the lesser of the useful life of the technology or 18 months. Research and development expenses are charged to operations as incurred. Research and development expenses as a percentage of relative business segment revenues are higher in the Technical Drawing segment than the other two business segments due to the relatively higher development costs of the IntelliCAD product. We have not capitalized certain software development costs subsequent to the establishment of technological feasibility, as these costs have not been material.

Research and development expenses for each of fiscal 1998 and 1999 increased in all three business segments primarily due to planned hiring in our development organization and staffing additions associated with the acquisition of certain technology and assets from third parties. See "Acquired Technology and Merger Expenses" on page 19 of this annual report. We believe we must continue to increase research and development spending on an absolute basis during fiscal 2000 and beyond to expand our product lines and introduce new language versions of our products to international markets.

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Sales and Marketing

                                          Fiscal Year Ended September 30,
                                       ----------------------------------------
                                        1997     1998    Change  1999    Change
                                       -------  -------  ------ -------  ------
                                                  (in thousands)
Sales and marketing................... $40,576  $68,596    69%  $82,523    20%
Percentage of revenues................      40%      41%             41%

Sales and marketing expenses have increased each fiscal year as we continue building our worldwide sales, marketing and customer service infrastructure. Sales and marketing expenses as a percentage of relative business segment revenues are higher in the Technical Drawing segment than the other two business segments due to relatively higher product marketing costs for the IntelliCAD product. The increase in sales and marketing expenses for each of fiscal 1998 and 1999 was primarily due to expansion in international markets, increased product marketing costs to introduce and support new products and product upgrades and investment in the corporate sales force and the Volume Licensing programs. This increase was partially offset in fiscal 1999 by certain efficiencies gained as a result of the merger with Kaspia in July 1998. We believe substantial spending on marketing awareness and corporate sales staffing is essential to achieve revenue growth and to maintain and enhance our competitive position. Accordingly, we expect sales and marketing expenses will continue to increase in absolute terms over time.

General and Administrative

                                           Fiscal Year Ended September 30,
                                         ---------------------------------------
                                          1997    1998    Change  1999    Change
                                         ------  -------  ------ -------  ------
                                                    (in thousands)
General and administrative.............. $8,353  $12,973    55%  $15,500    19%
Percentage of revenues..................      8%       8%              8%

General and administrative expenses increased in each of fiscal 1998 and 1999 in absolute terms primarily due to increased staffing and costs required to support our growth. This increase was partially offset in fiscal 1999 by certain efficiencies gained as a result of the merger with Kaspia in July 1998. We expect general and administrative expenses to increase in absolute terms in future periods as we continue to develop a sufficient infrastructure to support our revenue growth. We expect that general and administrative expenses as a percentage of revenues will decline over time.

Acquired Technology and Merger Expenses

For all acquisitions accounted for under the purchase method, assets are recorded at fair market value. The allocation of the purchase price to acquired technology or capitalized technology is based on known valuation techniques in the software industry. For some transactions, we obtain an independent appraisal of the technology. Amounts allocated to acquired technology relate to in-process research and development that were immediately expensed in the period of acquisition because technological feasibility was not established and no alternative commercial use was identified. Amounts allocated to capitalized technology relate to technology that had achieved technological feasibility at the time of acquisition. Capitalized technology is amortized on a straight-line basis over the estimated useful life of the technology.

Boomerang Technology Acquisition. On February 21, 1997, we acquired certain technology and assets of Boomerang Technology Inc., a privately held developer of Autodesk AutoCAD-compatible software, located in San Diego, California. Under the terms of the agreement, we acquired source code and certain other assets for a cash payment of $6.7 million. This transaction was accounted for using the purchase method and resulted in a charge to acquired technology and merger expenses of $6.7 million for in-process research and development in fiscal 1997.

19

SysDraw Software Company Acquisition. On May 1, 1997, we acquired certain assets of Freedom Solutions Group, Inc., d.b.a. SysDraw Software Company, a privately held network design and documentation solutions provider, located in Lombard, Illinois. Under the terms of the agreement, the acquisition price included $5.8 million in cash plus the issuance of a $1.0 million note payable, the principal and interest of which we paid in August 1998. In addition, pursuant to the agreement, in August 1999 we paid $1.5 million of additional consideration as certain revenue performance goals of the acquired product were met within three years of the acquisition date. The transaction was accounted for using the purchase method and resulted in capitalized technology of $3.1 million, other assets of $100,000 and a charge to acquired technology and merger expenses of $3.6 million for in-process research and development in fiscal 1997. The capitalized technology is being amortized on a straight-line basis over five years in the IT Design and Documentation segment. The additional consideration of $1.5 million paid in August 1999 was recorded as capitalized technology and is being amortized over the remaining life of the technology.

Merger with MarComp. On January 22, 1998, we merged with MarComp, a privately held provider of programming toolkits for access to Autodesk's AutoCAD .dwg and .dxf file formats, located in Parkton, Maryland. Under the terms of the merger agreement, we exchanged 50,014 shares of our unregistered common stock for all of the outstanding shares of MarComp. The transaction was accounted for as a pooling of interests and, due to the immateriality of the amounts involved, prior period financial statements have not been restated. The transaction resulted in an increase in equity of $109,000 primarily due to the acquisition of cash and accounts receivable from MarComp and resulted in approximately $100,000 in merger related costs in fiscal 1998.

InfoModelers Technology Acquisition. On February 10, 1998, we acquired certain technology and assets of InfoModelers, Inc., a privately held supplier of database and data warehouse visual design, access and query tools, located in Bellevue, Washington. Under the terms of the agreement, we issued 200,000 shares of our unregistered common stock for accounts receivable, fixed assets, tax assets and certain technology assets. The transaction was accounted for using the purchase method and was valued at approximately $8.0 million for InfoModeler shareholders. This transaction resulted in a total charge to acquired technology and merger expenses of $7.0 million for in-process research and development in fiscal 1998. In addition, we recorded approximately $1.0 million in other assets.

Decision Graphics Technology Acquisition. On May 5, 1998, we acquired certain technology from Decision Graphics U.K. Ltd., a privately held provider of computer-aided facilities management software, located in the U.K., for $729,000. The transaction was accounted for using the purchase method and resulted in a total charge to acquired technology and merger expenses of $729,000 for in-process research and development in fiscal 1998.

Ketiv Technology Acquisition. On June 2, 1998, we acquired certain CAD technology, software products and other assets from Ketiv Technologies, Incorporated, a privately held provider of architecture, engineering and construction software located in Portland, Oregon, for approximately $2.7 million. The transaction was accounted for using the purchase method and resulted in capitalized technology of $2.5 million and a total charge to acquired technology and merger expenses of $247,000 for in-process research and development in fiscal 1998. The capitalized technology is being amortized on a straight-line basis over five years in the Technical Drawing business segment.

Merger with Kaspia. On July 10, 1998, we merged with Kaspia, a privately held developer of fully automated enterprise-network audit functionality, including discovery, monitoring and reporting software, located in Beaverton, Oregon. Under the terms of the merger agreement, we acquired all of Kaspia's outstanding stock for 482,994 shares of our common stock, valued at approximately $23.3 million for Kaspia shareholders. This transaction was accounted for as a pooling of interests. Accordingly, our financial statements include the combined results of operations for Visio and Kaspia, and all prior financial statements have been restated. The transaction resulted in approximately $1.2 million in merger related costs in fiscal 1998.

20

Pending Merger with Microsoft. On September 14, 1999, we entered into an Agreement and Plan of Reorganization with Microsoft Corporation. For information regarding potential adverse effects in connection with that agreement, please see "Certain Risk Factors That May Impact Future Results of Operations" beginning on page 26 of this annual report. Through September 30, 1999 Visio incurred $1.5 million in merger related costs. We expect to incur at least an additional $2 million in fiscal 2000 for legal and accounting fees related to the proposed merger.

Interest and Other Income, Net

Interest income was $3.3 million for fiscal 1997, $4.4 million for fiscal 1998 and $4.3 million for fiscal 1999. The increase in fiscal 1998 compared to fiscal 1997 was primarily due to larger cash and short-term investment balances in fiscal 1998. Interest income in fiscal 1999 compared to fiscal 1998 was negatively impacted by lower interest rates. The negative impact was partially mitigated by an increase in invested cash and short-term investments. Other income includes grant income from the Industrial Development Agency of Ireland and gains and losses from unhedged foreign currency transactions. We conduct business in various foreign currencies and are therefore subject to transaction exposures that arise from foreign exchange rate movements between the dates that foreign currency transactions are recorded and the dates that they are settled. We hedge certain foreign exchange transaction exposures through the use of forward exchange contracts. To the extent we have assets and liabilities denominated in foreign currencies that are not hedged, we are subject to foreign currency gains and losses. At September 30, 1998 and 1999, approximately $7.9 million and $8.6 million, respectively, of forward exchange contracts were outstanding with maturities not exceeding 90 days. At September 30, 1998 we had a net asset forward exchange contract position of approximately $222,000. At September 30, 1999 we had a net liability forward exchange contract position of approximately $539,000. There have been no significant foreign currency transaction gains or losses to date with respect to these activities; however, there can be no assurance that our strategies will continue to be effective or that transaction gains or losses can be minimized or forecasted accurately. We do not hedge our translation risk.

Provision for Income Taxes

Our effective income tax rate was 25% for fiscal 1997, 25% for fiscal 1998 and 26% for fiscal 1999. The statutory tax rate in the U.S. was 34% for fiscal 1997 and 35% for fiscal 1998 and 1999. Our effective tax rate was lower than the statutory rates for the respective years due to income taxed in foreign jurisdictions at rates lower than in the U.S. Although the effective tax rate remained flat during fiscal 1998 as compared to fiscal 1997, the mix of significant components within income taxes changed. In fiscal 1998, income taxes decreased due to 1) an increase in the percentage of income taxed in foreign jurisdictions at rates lower than in the U.S., 2) an increase in tax- exempt interest income, 3) an increase in research and development credits and
4) tax benefits from the utilization of net operating loss carryforwards obtained in the acquisition of certain technology and assets from InfoModelers and the merger with Kaspia in fiscal 1998. Offsetting this decrease in income taxes was the tax effect of non-deductible acquired technology and merger expenses incurred in fiscal 1998. The effective tax rate in fiscal 1999 increased compared to fiscal 1998 due to a decrease in the percentage of income taxed in foreign jurisdictions at rates lower than in the U.S. and due to an increase in the percentage of income incurring state income taxes. No provision has been recorded for federal income taxes on unremitted earnings of certain of our foreign subsidiaries since we plan to reinvest all such earnings for the foreseeable future. At September 30, 1999, cumulative unremitted earnings from these subsidiaries were $48.0 million. As of September 30, 1999, total income taxes related to unremitted earnings in the foreign subsidiaries was approximately $11.3 million. No tax provision has been recorded for this liability since we plan to reinvest all such earnings for the foreseeable future.

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