Microsoft: The Latest Victim of Expectations

Microsoft became the latest company to be hurt by high expectations as the software goliath posted an 81 percent increase in net profit and a15 percent sales growth, but fell short of forecast targets and took it on the chin on Wall Street as a result.

In a report rife with recurring themes from this earnings season, Microsoft said revenue in its fiscal fourth quarter climbed to US$9.29 billion, while profits grew 81 percent to $2.69 billion, falling short of expectations by a penny per share. Microsoft said a number of factors would mute profit growth going forward as well.

The news put a dent in Microsoft shares in morning trading Friday, with the stock down by 3 percent to 28.14.

Earlier in the week, Microsoft had injected the stock market with a needed boost when it announced the largest one-time dividend payout and other measures to return cash to shareholders over the next four years.

But many analysts were quick to praise the report and said Microsoft and other companies have suffered from soaring expectations about growth and earnings in the tech sector, expectations that might have been ratcheted to unrealistic levels in the first half of the year.

Growing an eBay or Two

Microsoft used its earnings conference call to portray itself as a technology company still growing many of its business units rapidly. CFO John Connors said all internal divisions met or exceeded company growth targets.

“All of our seven businesses are growing,” Connors said on the call. “I think it is important to put the number into context. It is just a bit lower than growing a couple of Yahoos or two eBays. We grew nearly two new companies that size in revenue growth.”

The growth question was raised anew this week in the wake of Microsoft’s decision to spin off as much as $75 billion in cash in the next four years through dividends and stock buybacks. Those actions are typically seen as stock-value enhancing measures undertaken by mature companies that grow profits but don’t see the kind of revenue growth that tech companies have been known for.

In fact, Connors acknowledged that double-digit revenue growth will be difficult to achieve because PC sales are expected to slow later this year and into 2005 and because some customers may choose to wait for the Longhorn platform to be released to upgrade their software.

Profit growth also is expected to decline for several reasons, including a change in investment strategy toward more conservative, lower-return vehicles that will leave Microsoft’s cash readily available for the dividend payouts.

Still Clicking

Gartner research director Martin Reynolds said the expectations scenario is the only way to explain the response to Microsoft’s results. The company was able to dispose of several major legal problems during the fiscal year, he noted, and finally acquiesced to calls to move its cash off its books.

Reynolds told the E-Commerce Times that the expirations of many of Microsoft’s controversial software-assurance subscriptions, which many customers have bought reluctantly in the past, could pose a threat to sales. “The overall picture remains pretty upbeat,” he added.

Other analysts noted that Microsoft defied the trend among some software companies by reporting growing sales, joining a small number of companies — including SAP and IBM — that were able to post strong numbers in what appears to be a softening sales environment.

“Microsoft is always going to be in the position to perform well under tough circumstances,” Enderle Group analyst Rob Enderle told the E-Commerce Times. “Companies are always going to go with the tried-and-true, especially when the future isn’t as certain as they might like.”

In fact, Microsoft slightly raised is fiscal 2005 revenue guidance, saying it expects sales of $38.4 billion and $38.8 billion, up from the earlier range of $37.8 billion to $38.2 billion.

Microsoft’s Windows client and Office groups continue to be the most profitable and best-performing of its business units. Lagging are the Xbox-centered entertainment division, which along with the business solutions unit and the mobile and embedded devices division posted net losses in the quarter.