Updated from 5:22 p.m. EDT

Microsoft ( MSFT) plans to save nearly $1 billion this year by slashing costs and operating more efficiently, but the software behemoth also acknowledges it needs to boost both top- and bottom-line growth to breathe life back into its stock.

That was part of the message that Microsoft CEO Steve Ballmer relayed Tuesday to the company's 57,000 employees in an annual letter, which also addressed the difficult balance the company must strike between its enormous size and its need to innovate.

The letter comes as investors have been speculating about what the world's largest software maker plans to do with its cash hoard, now sitting at a mind-boggling $56 billion. Microsoft has said it will address the issue by its July 29 analyst day, although some have speculated the company could announce something earlier as part of its fourth-quarter earnings report on July 22.

Addressing questions from employees about why Microsoft doesn't use that cash to save recently cut employee prescription drug benefits, Ballmer wrote: "Using the cash reduces profits, which reduces the stock price. The cash is shareholders' money, so we need to either invest in new opportunities or return it to them."

Goldman Sachs analyst Rick Sherlund took that statement as evidence of senior management's recognition that the company needs to address its cash position. On Wednesday, he reiterated a belief that the company can support a $40 billion stock-buyback program, which would add 9 cents to 10 cents of earnings per share. But the analyst also suggested Ballmer and Chairman Bill Gates may end up taking a more conservative path. (Sherlund has an outperform rating on Microsoft, and his firm has done banking with the company.)

Shares of Microsoft have climbed nearly 10% in the past three months as investors have started pricing in upcoming action from the company on its cash balance. But Microsoft's stock hasn't been able to break the $30 mark since last October. Shares recently fell 37 cents, or 1.3%, to $27.73 in after-hours trading Wednesday; shares closed up 8 cents, or 0.3%, at $28.10 in the regular trading session.

Still, Ballmer expressed optimism about boosting the share price.

"Obviously, we all want to increase the value of our stock, and we have the best opportunity to do that since the end of fiscal year 1998," Ballmer wrote. He noted that the stock was roughly at the same $25 level as it is now, while operating profits have more than doubled in the ensuing years.

But revenue growth during fiscal years 1998 and 1999 was about double the 13% and 14% it has been in the past two years. And analysts are expecting growth to drop substantially to 6% in fiscal 2005, which began July 1.

Ballmer said the key to increasing the stock price is increasing profits, the key to increasing profits is increasing revenue and the key to increasing revenue is innovation. "We cannot just cut costs," he wrote.

Still, for the first time, Ballmer disclosed the company's $1 billion goal for savings by cost cuts and efficiencies, even as the company has taken flak from employees for reducing the company's prescription benefits this year.

For example, Ballmer said, Microsoft will save hundreds of millions of dollars by driving more coordinated marketing in disciplines such as advertising. In addition, Microsoft reduced employees' discount on purchases of Microsoft stock from 15% to 10%, resulting in a savings of $370 per employee.

Even with such changes, Microsoft's cost per employee will rise 6% in fiscal 2005, largely due to increasing employee benefit costs, Ballmer said.

Transamerica Investment Management fund manager Chris Bonavico said Microsoft's focus on savings is partially the result of pressure from investors, who have focused on the company's $7 billion research-and-development budget.

"I think that he's got a little bit of pressure from investors saying, '$7 billion. Come on. You don't need to invent everything, like the wristwatch that you talk to,'" Bonavico said, referring to the company's so-called software-embedded SPOT (smart personal object technology) watch.

"They do need to say ... this isn't a university and we need to focus on high return-on-investment products and high growth-opportunity projects and not just nifty technology," added the fund manager, who is long Microsoft. "I know I've expressed that to the company."

To date, Microsoft has not identified R&D as a potential area targeted for cuts. A Microsoft representative declined to comment.

Further suggesting the company is sticking by its enormous investment in R&D, Ballmer stressed in his note to employees that the company's future depends on innovation. On that front, he called Longhorn, the next version of Microsoft's Windows operating system, a "significant step forward," with its vision of more integrated solutions.

In a research note, Sherlund noted that the launch date for Longhorn may have slipped to as late as 2007, as Microsoft had decided to add more security features and dedicate some development resources to its upcoming release of Service Pack 2, which will offer security improvements to Windows.

As for Microsoft's growth engine -- the PC market -- Ballmer projected the number of PC users worldwide to reach 1 billion by 2010, compared with more than 600 million today.

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