Microsoft's Rosy Earnings Have A Couple Of Dark Clouds

SQL Server, Visual Studio and the new Xbox will drive growth, but Windows client licensing and the Business Service division pose problems.

Paula Rooney, Contributor

July 21, 2005

3 Min Read

Microsoft predicts that next quarter's launches of SQL Server 2005, Visual Studio 2005 and Xbox 360 will elevate its revenue during its 2006 fiscal year, but the company expects another profitless year for its Microsoft Business Solutions (MBS) division.

"2006 is shaping up well. We're at the starting point of improving [our] multiyear licensing and improving revenue growth for the company," Microsoft CFO Chris Liddell said Thursday during the company's conference call on its 2005 fourth-quarter and full-year financial results and fiscal 2006 outlook.

Microsoft's top finance executives project stronger-than-average, double-digit revenue growth going forward, fueled by SQL and Visual Studio upgrades in its server and tools division. The Redmond, Wash., software giant also expects the launch of the Xbox 360 game console later this year to drive more than 50 percent revenue growth in its home and entertainment division.

For the next fiscal year, Microsoft expects earnings of $18.3 billion to $18.8 billion, or $1.27 to $1.32 a share, on revenue of $43.7 billion to $44.5 billion. For fiscal 2005, Microsoft reported a profit of $12.3 billion, or $1.12 per share, up from $8.2 billion, or 75 cents a share, in fiscal 2004. Fiscal 2005 sales totaled $39.8 billion, up from $36.8 billion the year before.

Despite Microsoft's rosy revenue forecast, its MBS unit remains a sore spot. For the quarter ended June 30, MBS posted an operating loss of $76 million, up 9 percent from the year-ago quarter, on sales of $247 million, which rose 11 percent year over year. MBS' fiscal 2005 revenue climbed 6 percent from a year earlier.

Still, those gains were offset by a 16 percent quarterly decline and 25 percent annual decline in MBS services revenue. Microsoft attributed the decreases to its shift to partner-led services. Higher sales and marketing costs in Microsoft's SMS&P group also contributed to the increased loss, company executives said.

"We expect double-digit revenue growth … including double-digit, 10 percent to 11 percent growth for MBS for the [2006 fiscal] year," Liddell said. "We want to see improved profitability [in MBS], but we're not likely to see that in the coming year."

Over the next 12 months, Microsoft expects continued improvement in overall IT spending, including increased PC spending by small and midsize businesses. It also anticipates rising revenue in its Windows client licensing business, which declined by 9 percent for the 2005 fiscal year.

The software giant continues to see a stronger mix of Windows sales driven through its OEM channel. For the 2005 fiscal year, Windows client sales were fueled by a 12 percent growth in OEM license units, even as other licensing declined.

Overall, Microsoft saw strong, multiyear license bookings and a strong renewal cycle for its Enterprise Agreements, well within its historical rate of 66 percent to 75 percent. The company also had double-digit growth in bookings, although long-term unearned revenue remained flat at $1.6 billion.

Company executives said client licensing sales will begin to outstrip OEM license revenue once the next version of Windows, code-named Longhorn, ships in the second half of 2006.

"We're hopeful that client licensing will begin to turn around with more clarity around Longhorn and its launch date," Liddell said, noting that Microsoft won't report any revenue on Longhorn or Office 12 until fiscal year 2007. "The lack of clarity around the date of Longhorn has some people holding off [on licensing]. As that clarity comes through with the [launch] date, those holding off may come back in."

For the fiscal 2006 first quarter ending Sept. 30, Microsoft projects revenue of $9.7 billion to $9.8 billion and earnings per share of 29 cents to 31 cents, a decline from the fourth quarter. Still, company financial executives said the launches of the SQL and Visual Studio 2005 editions in November and the XBox 360 later in the year will more than make up for any loss expected during the historically slow summer season.

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