October 17, 2002 2:40 PM PDT

Licensing buoys Microsoft again

update Microsoft blew away analysts' estimates for its first fiscal quarter, once again buoyed in part by a controversial corporate licensing plan.

The Redmond, Wash.-based company reported net earnings Thursday of $2.73 billion, or 50 cents a share for the quarter, ended Sept. 30, compared with $1.28 billion, or 23 cents a share, a year earlier. Revenue grew 26 percent to $7.75 billion, from $6.13 billion in the same period last year. Sequentially, sales jumped from $7.25 billion in the fourth fiscal quarter.

Microsoft took a $291 million charge to cover investment impairment, which affected results by 5 cents a share.

A consensus of analysts polled by First Call anticipated earnings of 43 cents per share. In July, Microsoft projected revenue between $7 billion and $7.1 billion, with earnings of around 41 cents to 42 cents per share for the quarter.

Financial analysts had been watching this quarter more closely than others, particularly as they try to assess the long-term impact of a controversial Microsoft volume-licensing plan and take a first look at Microsoft's new organization. Microsoft shifted its products into seven divisions, with some groups, such as the MSN online unit, publicly reporting revenue for the first time.

"Results for the first quarter were exceptionally strong, exceeding our expectations," John Connors, Microsoft's chief financial officer, said in a statement. "During the quarter, we saw broader customer adoption of our licensing programs than we anticipated, as customers recognized the value of entering into long-term licensing agreements for our products."

Microsoft on Thursday reported it had sold 67 million copies of Windows XP. The Professional version of Windows XP, targeted at businesses, sold particularly strongly and accounted for 63 percent of the operating system's sales. These sales helped offset weak PC sales gripping the industry, more light on which should come Thursday, when market researchers Gartner and IDC are expected to release third-quarter PC shipment details.

"The...higher-price, high-end Windows XP Pro?has enabled the company to show revenue growth in excess of the unit growth of the PC industry," Goldman Sachs analyst Rick Sherlund wrote in a Tuesday research note.

Connors offered guidance for Microsoft's second fiscal quarter, which ends Dec. 31. The company predicts that revenue will be in the $8.5 billion to $8.6 billion range, with operating income of $3.2 billion to $3.3 billion and earnings per share of 45 cents to 46 cents. For the full fiscal year, the company projects sales of $33.2 billion to $33.6 billion, operating income of $14.1 billion to $14.4 billion and earnings per share between $1.89 and $1.95.

Licensing quagmire
Analyst estimates exceeded Microsoft guidance partly because they anticipated last-minute sales from Microsoft's Licensing 6 program. Companies looking to participate in the program, which would guarantee reduced costs on future upgrades, had until July 31 to move to the "current" version of Microsoft software. Otherwise, they would not qualify for the program.

Companies faced the same deadline for signing on to the Licensing 6 program itself, which many Microsoft customers received poorly. The new program raised rates anywhere from 33 percent to 107 percent, according to market research company Gartner. Last week, Microsoft CEO Steve Ballmer acknowledged that the company could have done a better job of introducing and implementing the program.

Microsoft gained two benefits from the flurry of last-minute sign ups: Increased sales and more unearned revenue on the balance sheet. But the increase in unearned revenue was slower than in earlier quarters, in part because the deadline for new licensing sign-ups was set for a date one month into Microsoft's first fiscal quarter.

Under the Licensing 6 program, businesses pay for upgrades on an annuity basis. Microsoft accounts for the fees as deferred revenue, which is regularly accounted for as revenue on the balance sheet throughout the life of the contract.

In the fourth quarter, Microsoft posted $7.74 billion in unearned revenue, up $830 million from the third quarter. Unearned revenue swelled further during the just-reported first quarter to $9.13 billion--mostly from licensing--up from $5.85 billion a year earlier.

Most of this unearned revenue comes from software licensing, but not all. Microsoft also includes undelivered items, such as software moved through retail or technical support. The nonlicensing category accounts for anywhere from 10 percent to 25 percent of unearned revenue.

Financial analysts attempted to estimate the impact of Licensing 6, which in the long term could smooth out Microsoft revenue.

In a Monday research note, Prudential Securities analyst John McPeake predicted Microsoft's unearned revenue would grow 50 percent year over year. "We also think that due to Microsoft's Volume Licensing changes, the company will likely experience less volatility than others in the enterprise software space," he wrote.

New organizational results
Microsoft's first-quarter results reflect a recent reorganization of the company's business units, with some groups breaking revenue for the first time.

Under the old structure, Microsoft reported revenue for desktop applications, desktop operating systems, enterprise software, consumer and other products. For fiscal 2002, ended June 30, Microsoft reported revenue of $28.4 billion, up from $25.3 billion a year earlier. The revenue by group broke down into $9.6 billion from desktop applications; $9.3 billion from desktop operating systems; $5.1 billion from enterprise software; and $4.4 billion consumer and other products.

Under the new structure, Microsoft will report revenue for seven divisions: client, information worker, MSN, home and entertainment, CE/mobility, server platforms and business solutions. The client group includes desktop and embedded operating systems; information worker is made up of Office, other standalone applications and professional product support; MSN encompasses online network and access services; home and entertainment includes the Xbox game console, consumer hardware and software, PC online games and the TV platform; CE/mobility refers to mobile devices; server platforms is made up of server operating systems, .Net servers, developer tools, premiere support and consulting, training certification and Microsoft Press books; and business solutions includes Great Plains, bCentral and Navision.

The new organization separates sales for products that previously had been lumped together. Office and Great Plains, for example, were part of the desktop applications group. Microsoft moved Great Plains, the accounting application acquired last year for $1.1 billion, to the Business Solutions group. In July, Microsoft acquired its other major software component, Navision, for $1.45 billion.

The company also broke out MSN into a separate division, making the first quarter the first time revenue had been publicly disclosed for MSN. The move marks a renewed focus on the consumer Web and online access network, as Microsoft struggles to bring MSN to profitability. For the quarter, MSN's revenue dropped to $427 million compared with $430 million a year earlier, according to Microsoft.

Revenue for the client group rose 33 percent year over year to $2.85 billion. Strong Windows XP sales contributed greatly to the results.

The information worker division saw sales rise 26 percent to $2.27 billion, from $1.81 billion a year earlier. Microsoft is expected to release the next version of the group's product suite, code-named Office 11, in mid-2003.

Revenue for the home and entertainment division reached $485 million, up from $267 million year over year. Sales of consumer hardware and software declined, while the Xbox game console saw sales gains.

CE/mobility posted sales of $17 million, up from $14 million a year earlier.

Sales of server platforms reached $1.59 billion, up 14 percent year over year. The group benefited from strong sales of Visual Studio .Net and SQL Server.

Business solutions reported revenue of $106 million compared with $74 million a year earlier.

Regionally, the Americas accounted for $2.73 billion in sales, compared with $2.35 billion a year ago, up 17 percent year over year. Revenue for the Europe, Middle East and Africa region grew 36 percent to $1.5 billion from $1.11 billion a year earlier. Japan and Asia-Pacific saw a 24 percent sales increase, to $860 million from $692 million a year earlier.

Original equipment manufacturer (OEM) revenue reached $2.65 billion, a 34 percent increase over the $1.98 billion posted a year earlier.

Microsoft ended the quarter with $40.9 billion in cash, up from $38.7 billion the previous quarter.

 

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