Microsoft Financial Results Disappoint Wall Street

Published: July 23, 2008

by Alex Woodie

Microsoft published its fourth-quarter and year-end financial results for fiscal 2008 last week, and the numbers did not please Wall Street. While revenues were up nearly 20 percent from a year ago and pre-tax profit up 40 percent, Microsoft did not hit the earning per share (EPS) number that financial analysts had set earlier in the year, and as a result, its stock price declined, taking billions of dollars in value with it.

At first glance, Microsoft's results seemed to be pretty good. For the four quarter ended June 30, the company reported revenue of $15.84 billion, an 18 percent increase from the same period a year ago. Operating income came in at $5.68 billion, a 42 percent increase, while diluted EPS was $0.46, a 48 percent bump and within its projected range. For its fiscal year, Microsoft had revenue of $60.42 billion, also an 18 percent increase from last year. Operating income for the year was $22.49 billion, a 21 percent jump, while EPS of $2.87 represented a 32 percent increase.

Microsoft executives grabbed onto the $60 billion revenue figure, calling it a milestone for the company. Indeed, the company surpassed $50 billion in sales for the first time just in fiscal year 2007 ($51.1 billion to be precise). That corresponded with the fastest rate of annual revenue growth for the company since 1999, near the peak of the dot-com stock market bubble mania. "We had a strong finish in the fourth quarter, which capped off an impressive year for the company," noted Microsoft CFO Chris Liddel in the earnings release.

But Wall Street was not impressed. Immediately following the earnings release at the end of trading last Thursday, brokers sold off the stock, sending its price down from $27.75 to below $25.50, about an 8 percent drop. The culprit? Microsoft failed to meet the EPS consensus estimate of 47 cents per share. While it missed it by just a penny, it was the first time in about a year that Microsoft failed to outperform its EPS projections, and that made the boys and girls on Wall Street--already edgy from a roller-coaster up-and-down week--freak out a little bit. But Microsoft shouldn't feel too bad: rival Google also failed to hit projections, sending its stock down from about $530 per share to $480 per share, nearly a 10 percent drop.

Despite what Wall Street thinks, it's tough to look at Microsoft and say "there's a company that's really in distress." Buoyed by its existing monopoly on the desktop and its increasing dominance in the data center, the company delivered profit by the boatload, increased its dividend to shareholders, and exceeded its own fiscal '08 revenue and profit projections from a year ago (it was the interim EPS update that did Microsoft in). The company also rolled out a slew of new products in its Business Division during the year that will likely see the good times continuing for the Redmond, Washington, software giant.

Sales were driven by Microsoft's three biggest divisions--Client, Server and Tools, and the Microsoft Business Division--which collectively averaged a 15 percent increase in revenue compared to a year ago.

The Client division, which sells the Windows Vista and XP operating systems, brought in $4.4 billion for the quarter and $16.9 billion for the year, increases of 15 percent and 13 percent, respectively. That roughly corresponds with the 12 to 14 percent increase in worldwide PC shipments for the period, according to Microsoft. Operating income for the unit was steady at $3.2 billion for the quarter and $13 billion for the year.

The Server and Tools division, which sells the Windows Server system, Visual Studio, and related middleware components, reported a 21 percent increase in revenue for the quarter to $3.7 billion, while for the year, the division reported sales of $13.1 billion, an 18 percent boost. Operating income for the quarter jumped 39 percent to $1.4 billion, while profit for the year was up 26 percent to $4.6 billion. Microsoft managed to increase its bottom line while simultaneously absorbing a 23 percent increase in general and employee-related costs., including the need to hire more consultants. On the flip side, a sudden surge in consulting resulted in a 30 percent increase in consulting revenue for Microsoft.

The Microsoft Business Division, which sells Office and Dynamics CRM tools among other products, grew its sales 14 percent for the quarter, to $5.26 billion. For the year, MBD revenue increased 15 percent, to $18.9 billion. However, things weren't nearly that rosy, as favorable currency exchange rates contributed about $266 million, or six percentage points, to the quarterly number, and $724 million, or four percentage points, to the yearly figure. A bright spot for the quarter was the SharePoint suite, which saw its sales jump 30 percent during the quarter.

The Online Services Business also saw a nice bump, up 24 percent for the year to $840 million, and up 32 percent for the year to $3.2 billion. The rise in revenue is attributable to the acquisition of the online ad firm aQuantive, which Microsoft bought for $6 billion in August 2007. However, the division was still not able to turn a profit, as it lost $488 million for the quarter, a 132 percent change, while the loss for the year came in at $1.23 billion, just a 100 percent increase from the loss posted a year ago. One bright spot was number of Windows Live IDs, which increased by 20 percent, to 460 million as of June 30.

Xbox 360 sales propelled Microsoft's final segment, the Entertainment and Devices Division, to a 37 percent increase in revenue for the quarter, to $1.6 billion. For the year, this division brought in just over $8 billion, a 34 percent jump from the year-ago period. While EDD finished the fourth quarter with a $188 million loss (an improvement on the $1.2 billion quarterly loss last year), it managed to eke out a $429 million profit for the year. That was a considerable improvement on last year, when it lost nearly $2 billion for the year.

Microsoft also released its earnings expectations for the next quarter and the year. It predicted revenue to be between $14.7 billion to $14.9 billion, operating income to be between $5.9 billion and $6 billion, and EPS to be from $0.47 to $0.48. Wall Street has its own sets of estimates for Microsoft, and it thinks the software giant can hit $0.49. Obviously, when Microsoft doesn't hit that figure, it must be punished.

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