July 17, 2003 3:56 PM PDT

AOL settlement dents Microsoft earnings

Despite beating sales targets, Microsoft reported lower fourth-quarter earnings than expected on Thursday, hit by the costs of a legal settlement with AOL Time Warner.

For the three months ended June 30, the software giant earned $1.92 billion, or 18 cents a share, on revenue of $8.07 billion. Those results compare with earnings of $1.53 billion, or 14 cents per share, on revenue of $7.25 billion for the same quarter a year ago.

The past-quarter results include a 5-cent charge per share related to the settlement, while the year-ago results include a charge of 7 cents per share for declines in Microsoft's investment portfolio.

The settlement charge relates to Microsoft's May announcement that it would pay $750 million to AOL Time Warner to settle an antitrust suit filed in January 2002 by AOL's Netscape unit.

Even excluding the settlement charge, Microsoft's earnings of 23 cents per share were a penny below forecasts. On average, analysts were expecting the Redmond, Wash., software company to report fourth-quarter earnings of 24 cents on revenue of $7.88 billion, according to tracking firm First Call.

"In the fourth quarter, sales came in better than expected, reflecting solid corporate and consumer demand for our products," John Connors, Microsoft's chief financial officer, said in a statement.

In April, Microsoft gave projections for similar fourth-quarter results, estimating revenue at between $7.8 billion and $7.9 billion and per-share earnings of either 23 cents or 24 cents.

Looking ahead
For the current first quarter, the company said it expects revenue of between $7.9 billion and $8.1 billion, with earnings of around 23 cents per share. That earnings projection includes an estimated 6 cents per share in charges related to Microsoft's decision to expense the cost of granting stock options to employees. That decision came alongside Microsoft's announcement that it would switch to giving its workers grants of stock, rather than options, starting this quarter.

Microsoft also raised its revenue outlook for the current fiscal year, 2004, saying it now expects revenue in the range of $34.2 billion to $34.9 billion, up from an earlier forecast of between $33.1 billion and $33.8 billion.

However, operating income and per-share earnings will be less than earlier forecast, because of the decision to expense the costs of stock-based compensation, the company said. It now expects operating income in the range of $11.3 billion to $11.6 billion, including an equity compensation expense of approximately $3.9 billion. It predicts earnings of between 85 cents and 87 cents per share, including 24 cents in stock compensation expenses.

In April, Microsoft forecast operating income between $14.8 billion and $15.1 billion and earnings per share between $1.04 and $1.06, with no charges for equity compensation.

The earnings results and outlook follow a better-than-expected report on second-quarter PC sales from research firms Gartner and IDC.

On a conference call with analysts, Connors said Microsoft has no immediate plans to distribute a significant chunk of its $49 billion in cash holdings to shareholders. Connors said legal and business uncertainties were behind the decision not to immediately raise its dividend or to offer a one-time payout to shareholders, as some investors had hoped Microsoft might do.

"We are not going to have a dividend program change or a (new) stock buyback commitment," Connors said. "We really have to get through a couple of significant legal issues...most notably the EU as well as the Sun antitrust case."

Connors said the company plans to talk with analysts at a meeting next week about changes it could make, but added that until the legal issues are resolved, Microsoft doesn't feel it would be prudent to commit to a long-term change.

Although the company saw better-than-expected sales in the June quarter, Connors said, the company does not foresee a major pickup in technology spending.

"IT budgets remain tight, and customers are more focused on cost control than (on) investment," Connors said, adding that the company expects PC growth in the current quarter to be in the low single digits, with somewhat better growth for servers.

For its MSN business, Connors said the company expects a continued decline in subscribers to hurt sales, with any pickup in advertising only partially offsetting a fall in subscription-fee revenue.

Additionally, he said Microsoft benefited from currency fluctuations that may not similarly benefit it in coming quarters.

Unit sales
Microsoft said sales in its Client unit, which produces the desktop version of Windows, were $2.53 billion, up from $2.43 billion a year ago. Revenue from server software was $1.93 billion, up from $1.64 billion a year ago. The Information Worker segment, which includes sales of Microsoft Office, tallied sales of $2.35 billion, up from $2.17 billion a year earlier.

Microsoft said its MSN online unit had revenue of $559 million, up from $447 million a year earlier.

"In the past year, we have made significant progress with both our performance-based advertising and our brand advertising on the MSN network," Yusuf Mehdi, corporate vice president of MSN, said in a statement. "The MSN business will continue to focus on providing the best Internet experiences for consumers and advertisers, while maintaining our path toward profitability."

The Home and Entertainment unit, which oversees the Xbox game console, totaled $483 million in sales, up from $448 million a year ago and ahead of company expectations.

Microsoft said it has sold more than 9.4 million Xboxes since launching the product in 2001, and it expects by July next year to have sold between 14.5 million and 16 million games consoles. The company said it now has more than 500,000 subscribers for its Xbox Live online game service.

The Mobile and Embedded devices unit saw revenue of $44 million, up from $36 million a year ago. Business Solutions, which covers Great Plains and bCentral, reported revenue of $179 million, up from $86 million a year earlier.

Microsoft shares climbed to $27.08 in after-hours trading on Island ECN. In regular trading, shares closed at $26.69, off 83 cents, or 3 percent.

 

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