Server Sales Continue to Propel Microsoft

by Alex Woodie

Continued strong demand for Windows servers and Windows server software boosted Microsoft's fortunes for the fourth quarter and fiscal year 2005, according to financial results posted last week. Profits from the company's Server and Tools division more than doubled for the year ended June 30, reflecting the solid double-digit revenue growth for the division, which brought in more than $1.3 billion more during fiscal year 2005 than 2004.

All in all, the financial results were very positive for Microsoft, which is riding the wave of increased demand for Windows server gear, while trying to spur growth for Windows PCs and desktop applications, a segment that isn't growing as fast but still accounts for the majority of the company's revenues and profits. Strong sales of the X-Box game console, as well as fluctuations in global currency, also helped to propel the Redmond, Washington, company.

Total revenues for the fourth quarter came in at $10.2 billion, an increase of about $870 million, or 8 percent, from the previous year. Net income for the quarter came in at just under $3 billion, a 5 percent decrease from the fourth quarter of 2004. Microsoft took a sizable hit in the fourth quarter due to its antitrust settlement with IBM (see "Microsoft Settles OS/2 Antitrust Lawsuit with IBM for $850 Million"), which subtracted $756 million from the bottom line for the last quarter. Without that settlement, profits would have been up nearly 20 percent.

Fiscal year 2005 revenues came in at $39.8 billion, an increase of about $3 billion, or 8 percent, from 2004 revenues. Net income for the year increased a whopping $5.5 billion to $14.5 billion, which represents a 61 percent gain from the $9 billion the company reported for all of 2004.

"We closed out a record fiscal year with strong revenue growth in the fourth quarter driven by healthy, broad-based demand across all customer segments and channels," said Chris Liddell, chief financial officer at Microsoft. "While continuing to invest in the business, we also returned $44 billion to investors through share repurchases and dividends during the fiscal year."

The company says its revenue increase for the three months ended June 30, 2005, was driven primarily by increased licensing of Windows Server operating systems and other server applications, an increase in Xbox revenue, growth in licensing of Windows Client operating systems through original equipment manufacturers (OEMs), as well as favorable fluctuations in foreign currency exchange rates. The company cited similar drivers propelling the company's yearly revenue, with the addition of increased licensing of Office and other Information Worker products throughout the year.

The Server and Tools segment grew the fastest of Microsoft's seven segments. This segment brought in nearly $2.7 billion for the quarter, a 15.5 percent increase, and $9.9 billion for the whole year, a 15.8 percent increase. In terms of profitability, the Server and Tools segment brought $800 million to the bottom line in the fourth quarter, about a 32 percent improvement, while the big news was the segment's 130 percent jump in profitability for the entire year, from just over $1.4 billion to just under $3.3 billion. With SQL Server 2005 due to ship this fall, and plenty of Windows 2000 Server users out there who will make the jump to Windows Server 2003, this segment is looking good in the foreseeable future. The company's Server and Tools division outperformed the overall market for servers, according to Microsoft, which estimates the overall server hardware shipments grew from 10 to 11 percent for the quarter.

Things are not as rosy throughout the Microsoft juggernaut as they are in the Server and Tools division. Information Worker, which sells the Office suite, posted a modest 2.5 percent increase in revenue for the quarter, and a measly 1.2 percent jump in profit. The Client division fared somewhat better, posting a 10 percent jump in revenues for the quarter, and a 7.7 percent increase in profits.

Revenues from the Information Worker and Client divisions lagged somewhat in comparison to overall unit shipments and didn't reflect the moderate-to-strong up tick in global PC sales experienced last quarter. The company estimates that worldwide PC shipments grew 14 percent to 16 percent for the quarter, "driven by strong business demand in both emerging and mature markets."

It's a mixed bag for Microsoft looking forward to 2006. The company sees worldwide PC shipments growing between 7 percent and 9 percent (a slower rate of growth than has been experienced recently), and server unit shipments growing between 11 percent and 13 percent for fiscal 2006, a rate of growth that is comparable to what Microsoft says it experienced for fiscal year 2005.

In terms of revenue forecasts, Microsoft expects fiscal 2006 to bring in anywhere from $43.7 billion to $44.5 billion, which represents an increase of 10 to 11 percent compared to fiscal 2005 revenues. CFO Liddell says 2006 looks to be a "strong year for growth and investment."