Microsoft: Hot Results, Cool Outlook


By Jay Greene Microsoft (MSFT) closed out fiscal 2004 with a bang. But fiscal 2005 looks like it'll start with a whimper, and for that Wall Street is punishing its shares. They were down 3% early on July 23 to just $28, helping to pull the overall market sharply lower. On July 22, the world's largest software company reported a 15% revenue gain, to $9.3 billion, in the fourth quarter ended June 30, aided by growing corporate spending on PCs and servers that run Microsoft's Windows operating system. Annual sales jumped 14%, to $36.8 billion.

Microsoft couldn't resist crowing about adding $4.6 billion in new revenue during the year. Microsoft Chief Financial Officer John Connors says that amount alone is "just a bit lower than growing a couple of Yahoo's (YHOO) or two eBays (EBAY)."

THREE CHALLENGES. In a July 22 conference call with analysts and journalists, Connors discussed the Colossus of Redmond's results. For the quarter, Microsoft earned $2.7 billion, or 25 cents a share, compared to $1.5 billion, or 14 cents a share, in the same period a year earlier. After backing out one-time items, earnings fell a penny a share shy of analyst expectations. For the year, Microsoft earned $8.2 billion, or 75 cents a share, compared to $7.5 billion, or 69 cents a share, in fiscal 2003.

Still, Microsoft will have a hard time keeping up its revenue pace, and it acknowledged as much. It projects fiscal 2005 sales of $38.4 billion to $38.8 billion, about a 5% gain. While Wall Street gushed about Microsoft's July 20 announcement that it would dish out $75 billion in cash to shareholders over the next four years through dividends and stock repurchases, some investors worry that one of Corporate America's greatest growth engines is finally slowing down.

The challenge for Microsoft is that its three biggest businesses -- the Windows operating system for PCs, Windows and other software for servers, and the Office productivity suite -- are only inching ahead. Microsoft projects single-digit growth for all three business units in the current fiscal year.

BALANCING ACT. Gates & Co. says they believe the tech recovery will continue apace, particularly with corporate spending going strong. But tough comparable-period numbers, coupled with the expiration of several long-term corporate software-licensing contracts, will lead to sales of Windows for PCs climbing just 5% to 7% and Office sales expanding a mere 1% to 2%. The server business will do only slightly better, growing 8% to 9%, according to company guidance.

Looking beyond fiscal 2005, analysts believe the growth engine will pick up. But the question is: by how much? Charles J. DiBona, an analyst with Sanford C. Bernstein & Co., expects Connors and the rest of Microsoft's management to talk up growth prospects at Redmond's annual confab with analysts on July 29. Now that Microsoft has given value investors a reason to jump into the stock -- with a respectable 1.2% yield -- it will work to win back the growth camp with long-term glimpses into its product line.

"If they can pull that balancing act off, then the stock will get moving quite nicely," DiBona says. And if not, expect Microsoft shares -- at best -- to continue hovering much as they have for the last two years. Greene is BusinessWeek's Seattle bureau chief


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