How strong was Microsoft's fiscal 1999 earnings growth compared with prior years?

Net income rose from $4.49 billion in fiscal 1998 to $7.79 billion in fiscal 1999, a 73% increase. Diluted EPS climbed from $0.84 to $1.42. Part of this growth reflected higher investment income ($1.80 billion vs. $703 million) and a $160 million pre-tax gain on the sale of Softimage, not only operating improvements.

What is driving revenue growth, and what are the key risks to it?

Growth has been driven by Windows and Office adoption, particularly through OEM and organizational licensing. The filing notes that PC unit growth is slowing, replacement cycles are lengthening, desktop application penetration in large organizations is becoming saturated, and inexpensive or specialty devices reduce demand for traditional PC software. Future price pressure and delays in products such as Windows 2000 could also weigh on results.

What legal risks could affect Microsoft's business?

The most significant matter is the DOJ and state Attorneys General antitrust case, which challenges the integration of Internet Explorer with Windows; the trial began in October 1998. Other pending matters include Sun Microsystems' Java-related copyright and contract litigation, the Caldera suit over MS-DOS and Windows licensing, and a non-public SEC investigation into accounting reserve practices. Management believes none will have a material adverse impact, but outcomes are uncertain.

How much exposure does Microsoft have to its equity investments?

Equity and other investments were $14.37 billion at June 30, 1999, up from $4.70 billion a year earlier. The largest positions include AT&T convertible preferred debt (recorded at about $5.08 billion), Comcast, and MCI WorldCom. A 10% decline in equity securities would have reduced their carrying value by $1.37 billion, and the company hedges some highly volatile positions with options.

Does Microsoft pay dividends or carry significant debt?

Microsoft has never paid cash dividends on its common stock. It reports no material long-term debt and maintains $100 million in standby credit lines for foreign currency hedging and cash management. The company did pay $28 million in preferred stock dividends, and it repurchased $2.95 billion of common stock during the year, partly to offset dilution from employee stock options.

MSFT 10-K FY1999 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed September 28, 1999. Cited figures are marked; the original filing is the authoritative source.

Microsoft's fiscal 1999 10-K (year ended June 30, 1999) shows a company at the height of its Windows and Office franchise, with revenue up 29% to $19.75 billion^a and net income up 73% to $7.79 billion, or $1.42 per diluted share.

Operating income rose to $9.93 billion^b, and the operating margin held at roughly 50%, aided by lower cost of revenue (14.3% of revenue, down from 16.1%) and a rise in OEM and organizational licensing relative to retail packaged products. Revenue growth was driven mainly by Windows platforms ($8.59 billion) and productivity applications and developer products ($8.69 billion), with Consumer, Commerce, and Other still operating at a loss of about $1.07 billion. Investors should note that much of the reported earnings strength came from investment income of $1.80 billion, which was nearly 2.5 times the prior year's figure.

This was driven by a $5.0 billion^c AT&T convertible preferred investment and sizable stakes in Comcast, MCI WorldCom, Nextel, NTL, and others. Equity and other investments grew to $14.37 billion, and unrealized gains of $3.15 billion sit on the balance sheet. The company ended the year with $17.24 billion in cash and short-term investments, no material long-term debt, and stockholders' equity of $28.44 billion, and it has never paid cash dividends.

Operating cash flow reached $10.03 billion^d. The filing also flags material risks. The DOJ and 20 state Attorneys General antitrust case, which challenges the bundling of Internet Explorer with Windows, went to trial in October 1998, and the Sun Microsystems Java litigation and the Caldera DOS/Windows suit remain pending.

Management also disclosed that the company expects operating margins in fiscal 2000 may decline, citing higher operating expenses, the shift toward ratable revenue recognition, and the fact that cost of revenue gains are unlikely to continue. Management nonetheless described its outlook as optimistic.

02—Key points

Key Highlights

Revenue grew 29% to $19.75 billion in fiscal 1999, up from $15.26 billion in fiscal 1998.
Net income rose 73% to $7.79 billion, with diluted EPS of $1.42 (restated for the March 1999 two-for-one stock split).
Operating income reached $9.93 billion, while investment income more than doubled to $1.80 billion, contributing materially to pre-tax earnings.
Cash and short-term investments totaled $17.24 billion, with stockholders' equity of $28.44 billion and no material long-term debt.
Windows Platforms revenue reached $8.59 billion, and Productivity Applications and Developer revenue reached $8.69 billion, together accounting for roughly 88% of total revenue.
Consumer, Commerce, and Other operated at an operating loss of about $1.07 billion, reflecting continued investment in MSN, WebTV, and related online services.
Management warned that fiscal 2000 operating margins may decline, and the Department of Justice antitrust case and Sun Java litigation remain significant overhangs.

03—Questions

Frequently Asked Questions

How strong was Microsoft's fiscal 1999 earnings growth compared with prior years?
Net income rose from $4.49 billion in fiscal 1998 to $7.79 billion in fiscal 1999, a 73% increase. Diluted EPS climbed from $0.84 to $1.42. Part of this growth reflected higher investment income ($1.80 billion vs. $703 million) and a $160 million pre-tax gain on the sale of Softimage, not only operating improvements.
What is driving revenue growth, and what are the key risks to it?
Growth has been driven by Windows and Office adoption, particularly through OEM and organizational licensing. The filing notes that PC unit growth is slowing, replacement cycles are lengthening, desktop application penetration in large organizations is becoming saturated, and inexpensive or specialty devices reduce demand for traditional PC software. Future price pressure and delays in products such as Windows 2000 could also weigh on results.
What legal risks could affect Microsoft's business?
The most significant matter is the DOJ and state Attorneys General antitrust case, which challenges the integration of Internet Explorer with Windows; the trial began in October 1998. Other pending matters include Sun Microsystems' Java-related copyright and contract litigation, the Caldera suit over MS-DOS and Windows licensing, and a non-public SEC investigation into accounting reserve practices. Management believes none will have a material adverse impact, but outcomes are uncertain.
How much exposure does Microsoft have to its equity investments?
Equity and other investments were $14.37 billion at June 30, 1999, up from $4.70 billion a year earlier. The largest positions include AT&T convertible preferred debt (recorded at about $5.08 billion), Comcast, and MCI WorldCom. A 10% decline in equity securities would have reduced their carrying value by $1.37 billion, and the company hedges some highly volatile positions with options.
Does Microsoft pay dividends or carry significant debt?
Microsoft has never paid cash dividends on its common stock. It reports no material long-term debt and maintains $100 million in standby credit lines for foreign currency hedging and cash management. The company did pay $28 million in preferred stock dividends, and it repurchased $2.95 billion of common stock during the year, partly to offset dilution from employee stock options.

04—Continue

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