Microsoft's Uphill Stretch


By Jay Greene For the first time in its 19-year history as a public company, Microsoft (MSFT) posted single-digit annual revenue growth, with sales climbing just 8% in the fiscal year that ended June 30. But the software giant's new chief financial officer says the company is beginning to emerge from that trough, with double-digit growth anticipated in fiscal 2006.

Microsoft's annual sales hit $39.8 billion, with strength coming largely from its server division and growing revenue from its Xbox game-console business.

OPTION SWITCH. But single-digit growth in its two cornerstone businesses -- Windows sales for PC, which grew just 6% for the year, and Office sales, up 3% -- kept Microsoft's overall sales growth below 10%.

The number would have been worse had it not been for a 2 percentage-point boost from foreign exchange rates. The annual sales figures were largely in line with analyst expectations.

Microsoft's operating income jumped 61% for the year. That comes largely from Microsoft's move away from paying workers healthy doses of stock options, which only have value if the stock climbs, to more modest dollops of stock awards, which have value when they are granted.

SERVER STRENGTH. Microsoft also benefited from reduced legal costs, since it shelled out more than $2.5 billion in the previous fiscal year to settle litigation with Sun Microsystems (SUNW) and pay a fine imposed by the European Union for violating anticompetition laws there (see BW Online, 7/15/05, "Microsoft's Lengthy Legal Ledger").

And while the fiscal year's growth was thin, CFO Chris Liddell, who joined the company in May, says the numbers for the fourth quarter offered a glimpse of rallying fortunes. Sales climbed 9%, to $10.2 billion. Microsoft's booming server business continues to be the engine of its revenue growth. And while operating income fell 5%, to $3 billion, it was tagged by a one-time $756 million charge for antitrust claims, primarily to IBM (IBM).

What's more, with the debut of three key products in the coming fiscal year -- a new Xbox game console, SQL Server database software, and Visual Studio software tools for developers -- Liddell says that the company is entering "a period of improving revenue growth."

"LIGHT" QUARTER. Microsoft's expectations for those products put its fiscal 2006 guidance above analyst consensus. For the year, the company expects revenue of between $43.7 billion and $44.5 billion, which translates to 10% to 12% growth. Earnings are projected to come in at $1.27 to $1.32.

Even so, Microsoft shares slid in after-market trading. That's because its guidance for the fiscal first quarter fell a bit shy of consensus estimates. Redmond projects revenue for that period at $9.7 billion to $9.8 billion, below the $9.92 billion analysts had been estimating. And earnings per share should hit 29 cents to 31 cents, off from the 34 cents analyst consensus.

"I'm not sure anyone expected the first quarter to be as light as that," says Ed Johnson, senior analyst for the $700 million Allegiant Large Cap Value Fund, which holds about $17.5 million of Microsoft shares.

QUESTION TIME. With Microsoft shares having stagnated for the last three years, shareholder pressure may increase dividends or stock-buyback program. "They should be upping their annual dividend," says Sanford C. Bernstein analyst Charles DiBona. Despite Gates & Co. returning $44 billion to shareholders in the last fiscal year, it is still sitting on some $37.8 billion in cash. Without stock-price gains, investors will once again press for a piece of that money.

That pressure could come next week, at Microsoft's annual financial analyst meeting. It will be analysts' first opportunity to question Liddell -- and it will be his best chance to make a case that the worst has passed.

Greene is BusinessWeek's Seattle bureau chief


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