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Microsoft's mixed message
Software giant reports strong 4Q and raises '06 targets. Investors focus on lower fiscal 1Q outlook.
July 21, 2005: 6:41 PM EDT
By Paul R. La Monica, CNN/Money senior writer
Home on the
Home on the "range": Microsoft's stock hasn't moved much during the past three years.
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NEW YORK (CNN/Money) - Microsoft reported healthy gains in sales and better than expected earnings for its fiscal fourth quarter Thursday thanks to strong demand for its server software and Xbox gaming consoles.

But sluggish guidance for the company's next quarter disappointed investors. Shares of Microsoft (Research) slipped nearly 2 percent in after-hours trading following the release of its latest quarterly results, according to INET.

The world's largest software company said that sales for its fiscal first quarter of 2006, which ends in September, should be in a range of $9.7 billion to $9.8 billion. Wall Street was expecting revenue of $9.9 billion.

If Microsoft hit the $9.75 billion midpoint of its guidance, that would represent just a 6 percent increase in sales from the same period a year ago. Microsoft reported a 9 percent year-over-jump in revenue in its fiscal fourth quarter.

This deceleration of sales growth would appear to confirm what many Microsoft bears say about the company, namely that it is maturing and is going to have a tough time generating decent revenue growth for the foreseeable future. And Microsoft bulls were clearly hoping for a better near-term outlook. Hence, the drop in the stock.

"The revenue guidance for this quarter going forward was unimpressive. That's surprising people especially," said Michael Cohen, director of research with Pacific American Securities, adding that since several top PC manufacturers have reported robust growth in shipments lately, it's a bit of a mystery why Microsoft wasn't able to report stronger sales in its fourth quarter and also raise first-quarter guidance.

New products to boost sales in '06...

But the company did raise its sales target for all of fiscal 2006, however. Microsoft said it now expects revenue of between $43.7 billion and $44.5 billion.

The $44.1 billion midpoint is ahead of Wall Street's consensus estimate of $43.8 billion and is a nearly 11 percent increase from the $39.8 billion in sales that Microsoft reported for its recently completed fiscal 2005. Sales increased 8 percent year-over-year in fiscal 2005.

It also raised its earnings targets for fiscal 2006. The company said it now expects profits, including the cost of stock compensation, to be in a range of $1.27 to $1.32 a share, up from its previous forecast of $1.26 to $1.30 per share.

With that in mind, investors may be making a mistake by bidding the stock lower, said Jamie Friedman, an analyst with Fulcrum Global Partners.

He said investors should pay attention to the raised guidance for the full year, not the first-quarter number. He added that Microsoft reported a big gain in unearned revenue, sales which the company expects to record in coming quarters from license renewals. And that's a very encouraging sign.

The company said that unearned revenue came in at $9.2 billion, up from $7.9 billion at the end of March. Friedman said that this increase is a sign that Microsoft customers are perhaps not just waiting for the company's newest PC operating system, code-named Longhorn, to come out before buying more software. Longhorn is due out in the latter part of 2006.

But Friedman said some corporations are probably gearing up for another big product launch before then, the release of the next version of Microsoft's Windows SQL Server database software, dubbed Yukon.

"You have to conclude that companies are intrigued by Yukon and are upgrading. The unearned revenue is the best number we've seen for Microsoft in some time," he said.

Cohen said another reason Microsoft could see improving sales later on in the year is because of strong anticipated demand for the company's newest gaming console, Xbox 360, which is due out in November. "Xbox 360 could be big for Microsoft," he said.

During a conference call with analysts, Microsoft's new chief financial officer, Chris Liddell, confirmed that servers and tools software and home entertainment would be the biggest drivers of growth in fiscal 2006.

Liddell, who joined Microsoft from International Paper in May, expressed optimism that fiscal 2006 and beyond will be strong years for the company. He said PC growth should moderate but still be healthy, adding that the global economy looked stable and that information technology spending would be reasonably strong. He also said that this was "the start of a multi-year product cycle" for the company.

...but stock may stay stuck in the $20s

In addition to Yukon, Xbox 360 and Longhorn, a new version of Microsoft's Visual Studio Web development software is due out later this year and Office 12 is expected to be released in the second half of 2006.

Still, it doesn't appear as if this will be enough to cause investors to change their mind about the stock. To many, Microsoft still looks like a maturing firm with unexciting prospects.

Even with the boost to targets for fiscal 2006, Microsoft should, at best, probably post earnings gains in the low double-digits for the next few years.

As such, some analysts say investors probably shouldn't expect the stock, which has been mired in the mid-to-high $20 range for more than three years, to move significantly higher.

"The stock has probably bottomed out," said Alan Davis, an analyst with McAdams Wright Ragen. "But with no dramatic increases in earnings any time soon, the stock will probably increase in line with earnings growth."

For a look at more tech blue chip stocks, click here.

For more coverage of earnings season, click here.

Fulcrum's Friedman owns shares of Microsoft but his firm does not have a banking relationship with the company. Other analysts quoted in this story do not own the stock and their firms have not done investment banking for the company.  Top of page

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