January 16, 2003 2:57 PM PST
Microsoft sets dividend, splits stock
In an unexpected move, the software titan announced an annual dividend of 16 cents per share prior to a 2-for-1 stock split. The total payout will be $870.6 million, a fraction of its $40.5 billion cash reserves.
After charges and gains, Microsoft reported earnings Thursday of $2.55 billion, or 47 cents a share, compared with $2.28 billion, or 41 cents per share, a year earlier. The Redmond, Wash.-based company's second fiscal quarter ended Dec. 31.
Microsoft took a $210 million charge to cover an estimated $1.1 billion settlement of consumer class-action lawsuits in California. In the year-ago quarter, the company took a $660 million charge for another $1 billion settlement rejected by a federal judge. The company also took investment charges of $421 million and gained $126 million in a one-time tax benefit.
A consensus of analysts polled by First Call anticipated earnings of 46 cents per share. In October, Microsoft projected revenue between $8.5 billion and $8.6 billion, with earnings around 45 cents to 46 cents per share. The company had projected operating income of $3.2 billion to $3.3 billion.
In an unusual move, Microsoft waited about an hour after the market closed to issue the earnings release. Shares closed at $55.35, down 92 cents.
Microsoft's revenue soared to its highest quarterly level ever in part because of its game console Xbox, other consumer products, and continued strong demand for Windows XP and server software. The company launched four major products during the quarter: MSN 8, Windows XP Media Center Edition, Tablet PC and Xbox Live. Three of those products contributed to strong consumer sales.
But the Xbox may be the surprise performer. Last year, some financial analysts predicted Xbox sales would drag down Microsoft profits as much as 10 cents a share through fiscal 2004. But the company defied gravity, buoyed in part by strong Xbox Live and games sales. Microsoft has shipped 8 million game consoles since Xbox's launch in November 2001. The company sold 250,000 Xbox Live starter kits in the first 60 days after the device's release.
The company also reported increased demand for enterprise server software, with revenue up 12 percent. In addition, Microsoft continued to reap benefits from its Licensing 6 program, which moved a large number of customers to an annuity payment model. Under the program, customers pay for the software in annual payments during two- or three-year contracts. Microsoft initially records the money as unearned revenue, turning it into actual revenue over the life of the contract. Realization of unearned revenue accounted for about 22 percent of the quarter's revenue.
"The company delivered solid results in every business despite a challenging global economic environment," John Connors, Microsoft's chief financial officer, said in a statement. "While we are very optimistic about the future of the technology sector, we do not expect to see a significant upturn in global IT spending in the short term."
Connors offered guidance for Microsoft's third fiscal quarter, which ends April 30. The company expects revenue to be between $7.7 billion to $7.8 billion, operating income between $3.4 billion and $3.5 billion and earnings per share of either 47 cents or 48 cents. For fiscal 2003, Microsoft projects revenue of $31.9 billion to $32.1 billion, operating income of $14.1 billion to $14.3 billion, and earnings per share between $1.90 and $1.93.
In October, the company projected 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 for fiscal 2003.
Analysts had been watching this quarter for signs of how Microsoft might better use its cash hoard of nearly $41 billion. In a Wednesday research note, Deutsche Bank analyst Brian Skiba estimated Microsoft's cash stash would reach $53.5 billion by the close of fiscal 2003 in June and top $85 billion in fiscal 2005.
Skiba saw four major options for dealing with the cash: Buy back shares; make more acquisitions; increase lending through Microsoft Capital; or pay out dividends.
Microsoft's decision to pay out an annual dividend comes as Congress considers approving a White House proposal to end investor taxes on dividends.
"Declaring a dividend demonstrates the board?s confidence in the company?s long-term growth opportunities and financial strength," Connors said in a statement. "We are especially pleased to be able to return profits to our shareholders while maintaining our significant research and development efforts and satisfying our long-term capital requirements."
But during a Thursday afternoon conference call, some financial analysts questioned the size of the dividend, considering Microsoft's cash on hand.
"You could probably characterize our dividend as a starter dividend," Connors told financial analysts. He explained that Microsoft evaluated about 30 other companies paying out dividends. He indicated that Microsoft's board would continue to evaluate the dividend.
Solving Microsoft's cash problem remains a major concern for Wall Street, particularly as the company prepares to unleash a torrent of new products this year.
"Microsoft will release more new products in 2003 than ever before," Brendan Barnicle, a Pacific Crest Securities analyst, wrote in a research note on Wednesday. On tap: Windows 2003 Server, Exchange Server 2003, Office 11 and a new suite of server products code-named Jupiter, among others. "Historically (Microsoft) has spiked with new releases of Windows and Office," Barnicle wrote.
At the same time, Microsoft continues to benefit from unearned revenue, which is like having sales in the bank for upcoming quarters. The company ended the second quarter with $8.83 billion in unearned revenue. During the first quarter, unearned revenue swelled to $9.13 billion, mostly from licensing, up from $5.85 billion a year earlier.
The majority of unearned revenue comes from software licensing, but not all. Microsoft also includes undelivered items, such as software moved through retail or technical support, in the mix. The non-licensing category accounts for anywhere from 10 percent to 25 percent of unearned revenue.
Analysts also seemed hopeful about a Microsoft program that could diminish the threat of Linux and other open-source software from stealing customers from Windows. On Tuesday, Microsoft revealed that some governments would gain access to the Windows source code.
"The program is a pre-emptive move to prevent the replacement of Windows by Linux within government agencies, Microsoft's most-threatened vertical, Thomas Weisel Partners analysts Robert Schwartz and Tim Klasell wrote in a Wednesday research note. "This announcement demonstrates Microsoft's capability to defend and maintain its monopoly when the competition is feature-rich and free."
Connors told financial analysts that Linux remains a serious threat to Microsoft's server business. "The ramifications of free software to our business model should be obvious to everyone," he said.
This is the second quarter Microsoft has reported earnings under a new organization announced last summer. Under the new structure, the company reports 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 stand-alone applications and professional product support; MSN refers to the online network and access services; Home & 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.
In a routine filing with Securities and Exchange Commission, Microsoft in November revealed that under the new organization only Office and Windows turned a profit during the first quarter.
But some divisions, including MSN, entered the second quarter close to profitability.
Revenue for the Client group was $2.55 billion compared with $2.54 a year earlier. Strong Windows XP sales contributed greatly to the results.
The Information Worker division saw sales rise 8 percent to $2.29 billion from a year earlier. Microsoft is expected to release the next version of the group's product suite, code-named Office 11, by midyear.
MSN posted revenue rose to $459 million compared with $372 million a year earlier.
Revenue for the Home and Entertainment reached $1.33 billion, up from $960 million year over year, an increase of 38 percent. Sales of consumer hardware and software declined, while sales of Xbox, Xbox live and games increased.
CE/Mobility posted sales of $22 million, up from $17 million a year earlier.
Sales of Server Platforms reached $1.76 billion, up 12 percent year over year. The group benefited from strong sales of Visual Studio .Net and SQL Server.
Business Solutions reported revenue of $135 million compared with $73 million a year earlier.
Regionally, the Americas accounted for $3.26 billion in sales, compared with $3.16 billion last year, up 3 percent year over year. Revenue for the Europe, Middle East and Africa region grew 32 percent to $1.87 billion from $1.42 billion a year earlier. Japan and the Asia-Pacific region saw an 11 percent sales decrease, to $871 million from $785 million a year earlier.
Original equipment manufacturer (OEM) revenue reached $2.54 billion, a 7 percent increase over the $2.39 billion reached a year earlier.
The dividend is payable March 7 to shareholders of record on Feb. 21. The split is expected on Jan. 27.