How fast is Microsoft's revenue growing, and is the growth rate slowing?

Revenue grew 27% in fiscal 1998 to $14.48 billion, following 31% growth in fiscal 1997 and 46% in fiscal 1996. The deceleration reflects the large base, the shift from retail packaged products toward lower-priced OEM and organization licensing, and the ratable recognition of more revenue. Management does not provide forecasts and has said 1999 growth may not approach prior levels.

Is Microsoft's balance sheet strong enough to fund its investments and buybacks?

Yes. At June 30, 1998, the company held $13.93 billion in cash and short-term investments, carried no material long-term debt, and had $16.63 billion in equity. Operating cash flow of $6.88 billion covered $656 million in capital expenditures and $2.47 billion in share repurchases, leaving substantial room for strategic investments and acquisitions. Management expects existing resources to meet operating requirements for at least the next 12 months.

What are the biggest legal risks facing Microsoft?

The most significant is the May 1998 DOJ and 20-state Attorneys General Sherman Act case, which alleges Microsoft unlawfully tied Internet Explorer to Windows and may seek to restrict bundling and OEM licensing terms. Also pending are the Sun Microsystems Java suit, the Caldera antitrust suit with trial set for June 1999, and the DOJ consent decree contempt matter, which the appeals court sent back to the district court. Management believes none will have a material adverse effect on its financial position or results, but remedies could alter product distribution.

Why did the effective tax rate and one-time charges affect fiscal 1998 results?

The effective tax rate rose to 36.9% from 35.0% because the $296 million write-off of in-process technology from the August 1997 WebTV acquisition was not tax-deductible. Excluding that charge, earnings growth would have been stronger. The company also recognized other expenses from its share of joint venture losses, including DreamWorks Interactive and MSNBC.

What drives Microsoft's shift toward recognizing revenue over time?

Microsoft is bundling Internet technologies, telephone support, and unspecified enhancements into products such as Windows and Office 97, which requires a portion of revenue to be deferred and recognized ratably over the product life cycle, about two years for Windows and 18 months for Office 97. Unearned revenue rose to $2.89 billion at June 30, 1998, from $1.42 billion a year earlier. This improves earnings visibility but means reported revenue lags current sales.

MSFT 10-K FY1998 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed September 25, 1998. Cited figures are marked; the original filing is the authoritative source.

Microsoft's fiscal 1998 10-K (year ended June 30, 1998) shows a company still growing rapidly but beginning to show signs of deceleration.

Revenue rose 27% to $14.48 billion^a, net income grew 30% to $4.49 billion, and diluted EPS reached $1.67 (split-adjusted). Revenue growth slowed from 46% in fiscal 1996 and 31% in fiscal 1997, and management explicitly warned that growth in 1999 may not approach prior-year levels and that operating margins may decline as operating expenses rise. Operating income was $6.41 billion, and the operating margin held at roughly 44%, supported by cost of revenue falling to 8.3% of revenue.

The balance sheet remains exceptionally strong. Cash and short-term investments reached $13.93 billion^b, stockholders' equity was $16.63 billion, and the company carries no material long-term debt. Operating cash flow was $6.88 billion, up from $4.69 billion.

A growing share of revenue is recognized ratably, which lifted unearned revenue to $2.89 billion^c and provides better visibility into future earnings. Management continued aggressive share repurchases to offset employee option dilution, and it has not paid common cash dividends. The principal risks are legal and competitive.

The U.S. Department of Justice and 20 state Attorneys General filed a sweeping Sherman Act antitrust case in May 1998 centered on the bundling of Internet Explorer with Windows, and the Sun Microsystems Java litigation and Caldera lawsuit are also pending. Management believes these matters will not have a material adverse effect on financial position, but the outcome could affect product design and distribution practices. Competition from Linux, Netscape, and thin-client architectures is also cited as a longer-term threat to the Windows and Office franchise.

02—Key points

Key Highlights

Revenue grew 27% to $14.48 billion in fiscal 1998, though growth decelerated from 46% in 1996 and 31% in 1997.
Net income rose 30% to $4.49 billion; diluted EPS was $1.67, up from $1.32 in fiscal 1997 (split-adjusted).
Operating income of $6.41 billion includes a $296 million non-recurring write-off of in-process technology from the WebTV acquisition, which also raised the effective tax rate to 36.9%.
Cash and short-term investments totaled $13.93 billion against no material long-term debt, and stockholders' equity reached $16.63 billion.
Operating cash flow nearly doubled? No: rose to $6.88 billion from $4.69 billion, supported by growth in unearned revenue of $3.27 billion.
Management warned that fiscal 1999 revenue growth may not match prior years and that operating margins may decline due to higher planned investments in R&D, sales, marketing, and support.
The DOJ and 20 state Attorneys General filed a Sherman Act antitrust suit in May 1998 over the bundling of Internet Explorer with Windows; management calls the claims without merit.

03—Questions

Frequently Asked Questions

How fast is Microsoft's revenue growing, and is the growth rate slowing?
Revenue grew 27% in fiscal 1998 to $14.48 billion, following 31% growth in fiscal 1997 and 46% in fiscal 1996. The deceleration reflects the large base, the shift from retail packaged products toward lower-priced OEM and organization licensing, and the ratable recognition of more revenue. Management does not provide forecasts and has said 1999 growth may not approach prior levels.
Is Microsoft's balance sheet strong enough to fund its investments and buybacks?
Yes. At June 30, 1998, the company held $13.93 billion in cash and short-term investments, carried no material long-term debt, and had $16.63 billion in equity. Operating cash flow of $6.88 billion covered $656 million in capital expenditures and $2.47 billion in share repurchases, leaving substantial room for strategic investments and acquisitions. Management expects existing resources to meet operating requirements for at least the next 12 months.
What are the biggest legal risks facing Microsoft?
The most significant is the May 1998 DOJ and 20-state Attorneys General Sherman Act case, which alleges Microsoft unlawfully tied Internet Explorer to Windows and may seek to restrict bundling and OEM licensing terms. Also pending are the Sun Microsystems Java suit, the Caldera antitrust suit with trial set for June 1999, and the DOJ consent decree contempt matter, which the appeals court sent back to the district court. Management believes none will have a material adverse effect on its financial position or results, but remedies could alter product distribution.
Why did the effective tax rate and one-time charges affect fiscal 1998 results?
The effective tax rate rose to 36.9% from 35.0% because the $296 million write-off of in-process technology from the August 1997 WebTV acquisition was not tax-deductible. Excluding that charge, earnings growth would have been stronger. The company also recognized other expenses from its share of joint venture losses, including DreamWorks Interactive and MSNBC.
What drives Microsoft's shift toward recognizing revenue over time?
Microsoft is bundling Internet technologies, telephone support, and unspecified enhancements into products such as Windows and Office 97, which requires a portion of revenue to be deferred and recognized ratably over the product life cycle, about two years for Windows and 18 months for Office 97. Unearned revenue rose to $2.89 billion at June 30, 1998, from $1.42 billion a year earlier. This improves earnings visibility but means reported revenue lags current sales.

04—Continue

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