Microsoft Grows Yearly Revenue by 11 Percent

Published: July 26, 2006

by Alex Woodie

A strong fourth quarter that saw revenues increase 16 percent to $11.8 billion buoyed Microsoft's fortunes for 2006, as the software giant brought in $44.2 billion for the year, an 11 percent increase over 2005. Microsoft also did some housecleaning by making changes to its reporting structure--the number of reporting segments has been reduced from seven to five--and by announcing a $20 billion stock buyback plan.

These are challenging days for Microsoft, although you wouldn't necessarily know it by looking at its financial figures. (A look at its stagnating stock price, however, tells you what Wall Street thinks of the company.) Despite its problems (And wouldn't we all kill to have "problems" like Microsoft?), the software giant continues to be a revenue- and profit-generating machine, especially when it comes to its Windows desktop and Office divisions, and, increasingly, its Windows Server business, too.

For the year, the company reported net income of $12.6 billion, a three percent rise from fiscal year 2005, when it reported $12.3 billion. Earnings per share increased by seven percent for the year, from $1.12 per share to $1.20. For the fourth quarter, revenues increased by 16 percent to $11.8 billion, while net income came in at $2.83 billion, or $.28 per share, a decrease from the $.34 per share the company recorded for the same quarter a year ago.

Fourth quarter revenues actually exceeded Microsoft's expectations by $100 million to $300 million. "We delivered a very strong finish to the fiscal year highlighted by customer demand for our recently launched products of Xbox 360, SQL Server 2005, Visual Studio 2005 and Microsoft Dynamics CRM 3.0," said Chris Liddell, chief financial officer of Microsoft.

As usual, the company's Client segment led the way among Microsoft's seven operating units, with $3.38 billion in revenues, a 12 percent increase over fourth quarter 2005, a reflection of the strong PC market, which grew by 11 to 12 percent over the period.

The Server and Tools segment, which sells Windows Server, SQL Server, and Visual Studio products, brought in $3.18 billion last quarter, an increase of 18 percent from a year ago, and its 16th straight quarter of double-digit revenue growth.

This was also the first quarter that the Server and Tools segment's revenues eclipsed the revenues of the Information Worker segment, which sells the Office suite of products. Information Worker posted $3.13 billion in revenue, a 6 percent increase from a year ago.

Microsoft Business Solutions also posted strong results. Microsoft's ERP and CRM software division brought in $280 million for the quarter, a 16 percent increase from a year ago, largely on the back of a strong showing for CRM 3.0, which attracted more than 50,000 new users. Fiscal year 2006 marks the first time in this division's history that it has posted an operating profit.

The MSN unit continues to post disappointing results for the company, with a 3 percent dip in revenues to $580 million. Microsoft attributes this to a decline in advertising revenue as it ramps up its adCenter, which was fully operational by the end of the quarter, it said.

The Mobile and Embedded Devices segment continued its roller-coaster ride, posting a 41 percent increase in revenues to $113 for the quarter. Sales of Microsoft's embedded OS, Windows Mobile, enjoyed a 37 to 38 percent increase, according to Microsoft.

Lastly, the Home and Entertainment segment posted a solid quarter, bringing home $1.14 billion in revenues, a 94 percent increase from the same quarter a year ago, which was certifiably dismal in the shadow of the launch of the Xbox 360 game console. The continued success of the Xbox 360 was obviously the big story here, although MSTV also showed some life.

Microsoft managed to keep its costs in line last quarter, something it has struggled to do of late. While revenues increased 16 percent, operating expenses increased only 10 percent. A closer look at the company's figures reveals a change in spending allocations. For example, the company attributed $1.4 billion to "cost of revenue" in the fourth quarter of FY05, while the same figure last quarter accounted for $2.1 billion in costs, a 53 percent rise. However, "general and administrative" expenses decreased by 21 percent, to $1.1 billion.

Microsoft's income tax bill also increased substantially last quarter, from $161 million during the final quarter of 2005 to a whopping $1.4 billion in the fourth quarter of 2006. That 788 percent increase in taxes basically accounts for the difference in net income--$3.7 billion in Q4 2005 compared to $2.8 billion in the most recent quarter. For the year, the company's operating expenses increased 10 percent, closely tracking the 11 percent increase in revenue. However, its balance sheet shows the value of the company's assets actually declined by $1.2 billion, to $69.6 billion.

While it finished a mediocre 2006 on a strong note with a solid fourth quarter revenue-wise, the company's outlook for 2007 is mixed. Because Microsoft is entering the second-phase of a multi-year product cycle, income will lag revenues for the first half of 2007. However, profitability should pick up toward the end of fiscal year 2007, the company says. The timing of this outlook coincides with the delivery of Windows Vista and Office 12 in the first half of calendar year 2007--Microsoft's third quarter.

The company's outlook on a segment-by-segment basis will look different, as the company recently shook up its reporting structure. The number of reporting segments will shrink from seven to five. These will include the Client, Server and Tools, Online Services Group, Microsoft Business Division, and Microsoft Entertainment and Devices Division. Microsoft says these changes were made to reflect changes it has made recently in how it actually operates and gets work done.

What's more, these five segments will be grouped into three divisions--Microsoft Platforms and Services Division, which will include the Client, Server and Tools, and Online Services Group segments (Online Services Group, by the way, includes the old MSN and new Windows Live businesses); the Microsoft Business Division, which will include the Information Worker and the Microsoft Business Solutions businesses; and Microsoft Entertainment and Devices Division, which will include the former Home and Entertainment and Mobile and Embedded Devices businesses. Good luck tracking past segment's performance to the new structure.

Microsoft's board of directors has authorized a tender offer to buy back as much as $20 billion worth of stock through the beginning of August 2007. The plan calls for the company to buy stock between $22.50 and $24.75.

"With our share repurchase programs announcement today, we reaffirm our confidence and optimism in the long-term future of the company and continue to execute on our strategy of returning capital to shareholders," Liddell said.

Wall Street reacted to Microsoft's repurchase program by driving the price of its stock up about $1, from about $23 to about $24 per share. The stock had been trading in the $26-to-$28 range before its third quarter announcement, when the company revealed a surprising 11-percent increase in operating expenses.

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