Sitting PrettySitting Pretty

Linux, security flaws, product delays,regulatory oversight, and some unpopular licensing terms all represent ongoing challenges to Microsoft, but it's hard to see how they're hurting the company. Not only did Microsoft last week disclose plans to shell out $75 billion to its shareholders amid double-digit revenue growth, but it's cutting internal costs by $1 billion this year even as it does so.

Microsoft's plan to return $45 billion to investors through dividends and to buy back up to $30 billion of its shares over the next four years was so substantial that some wondered how far it might go in stimulating the U.S. economy. Even as all that money changes hands, Microsoft will keep upward of $20 billion in cash reserves, which CFO John Connors says will be available for acquisitions, investments, and as a general safety net.

"You might say, what's next for us? And the answer is record investment in innovation," Bill Gates, chairman and chief software architect, said in a conference call to discuss the company's payout plan. He pointed to Windows XP Service Pack 2, SQL Server 2005, Visual Studio 2005, and Longhorn as evidence of what comes next. "Lots of opportunity," he said.

Microsoft's fourth-quarter results, reported last week, show a company growing in all segments. Though adjusted earnings came up a penny short of analysts' expectations, revenue climbed 15% for the quarter ended June 30 compared with a year ago. Sales of Microsoft's server and tools business jumped 20% to $2.3 billion, while revenue from Office desktop applications surged 23% to $2.9 billion. Unearned revenue, a measure of the acceptance of Microsoft's multiyear licensing agreements, grew more than expected, to $8.2 billion. The vendor generated an 82% rise in profits for the quarter and raised its revenue forecast for the current year.

How's Microsoft doing it? For one thing, business customers continue to buy its products, despite ongoing concerns about security vulnerabilities in the Windows environment and worries about getting sucked too deep into Microsoft's money-making vortex. "Microsoft is going to be a huge part of our computing platform going forward, and I don't see a viable alternative any time down the road," says Scott Hicar, CIO of storage-drive manufacturer Maxtor Corp. "If you see one, let me know."

Conventional wisdom is that Linux and other open-source products, with the backing of Hewlett-Packard, IBM, Novell, and others, are emerging as that alternative platform. "By a long shot, the single biggest long-term competitive challenge to Microsoft is open-source Linux," says Lehman Brothers financial analyst Neil Herman.

Yet, in its most recent quarter, sales of Windows-based servers grew 18%, which was faster than the overall server market, according to Microsoft. "So far, we're competing well" against Linux, said CFO Connors in a conference call to discuss the company's fiscal 2004 financial results. In a recent survey by information Research, 80% of 300 respondents re- ported plans to buy Windows servers, compared with 37% who have plans for Linux servers.

Microsoft's emphasis on desktop-to-data-center integration, leveraged by its huge installed base, seems too attractive for many customers to resist. The company has long designed its products to work together, but the Office 2003 System and Windows Server System push the concept wider and deeper. Companies that want to use Microsoft's Sharepoint collaboration software, for example, need to run Windows not just on their desktop PCs but also on servers.

"It's all about integration," says Darryl Nitke, CIO of Cosa Instruments Corp., a small distributor of process and control equipment that recently replaced a multivendor IT infrastructure with Microsoft's software stack, including its Great Plains and customer-relationship-management applications. "I have everything I need, and it's not expensive."

Yet Microsoft integration isn't guaranteed. Nitke admits he's unsure if the Great Plains 8.0 application his company is installing will tie in seamlessly with version 2.0 of Microsoft's CRM application, due in the second quarter of next year. He's contemplating a third-party product as a workaround, just in case.

And where Microsoft products are tightly integrated, users can end up paying more. That's because new features can require upgrades to both PCs and servers at costs of up to 40% more for companies that don't have multiyear license agreements, Jupiter Research analyst Joe Wilcox says. "I expect that [trend] to continue as the integration increases going forward," he says.

By Microsoft's own account, one issue that's become less worrisome is the company's legal exposure. In explaining the decision to dole out $75 billion, senior VP and general counsel Brad Smith pointed out that Microsoft's antitrust settlement with the Justice Department recently received a favorable ruling from a U.S. appeals court; that Microsoft has resolved three-quarters of the state class-action suits against the company; and that it has settled a variety of antitrust and intellectual-property issues with Intertrust, Sun Microsystems, and Time Warner. "We have significantly reduced the legal risks facing the company," Smith said in a conference call.

An antitrust trial with the European Union hasn't been settled, but Microsoft believes potential damages are limited. When questioned about the future implications for Longhorn, Microsoft's next-generation operating system, Smith said there shouldn't be any. "The case won't get worse because there will be no opportunity for additional issues to be added," he said.

If anything, overseas markets represent ripe opportunities for Microsoft. Pirated versions of Windows and Office give it a big footprint in some emerging markets. And Microsoft is teaming aggressively with offshore outsourcers to ensure that its software gets pulled along by their rapidly growing services businesses (see story, below).

Microsoft also has signaled its willingness to grow through acquisition. Last month's revelation that Microsoft and SAP talked recently about merging was an indication that the vendor is open to a bold move that could significantly change the makeup of the industry.

In fiscal 2004, Microsoft's revenue grew by $4.7 billion, a 14% increase over the previous year. CFO Connors said Microsoft expects businesses to continue spending more on IT into its new fiscal year. The vendor plans to hire as many as 7,000 employees during the next 12 months and file for 3,000 patents. When asked whether Linux or security issues had put a crimp in Microsoft's business, analyst Herman paused, then said, "Not really."

Continue to the sidebar: "Looking East: Growing With Offshore Outsourcers"