November 18, 2002 1:08 PM PST

Office, Windows bring in the big bucks

Four of Microsoft's seven business divisions lost money in the most recent quarter, according to financial statements the company filed last week.

In the routine filing with the Securities Exchange Commission, the company also revealed Windows desktop profit margins were as high as nearly 86 percent.

Losses in the four divisions cast a shadow over Microsoft's fiscal 2003 first quarter, ended Sept. 30, despite volume licensing changes that helped boost revenue 26 percent. Profits from Windows desktop and Office, which in their respective categories have more than 90 percent market share, accounted for most of Microsoft's profits, according to the filing.

The SEC filing, called a 10-Q, offers the most insight to date on exactly where Microsoft makes money. Despite Microsoft's attempts to expand into new markets, the company remains heavily dependent on Office and Windows.

The business units making up Windows and Office brought in $4.88 billion in profits for Microsoft. But $830 million in losses for the four other divisions reduced earnings to $4.05 billion, according to Microsoft's 10-Q.

"For Microsoft, this shows there are some businesses that are almost start-ups for them," Gartner analyst Michael Silver said. "Those businesses are basically funded by Windows and Office."

A Microsoft representative said that the company prefers to take a long-term view of the financial health of its divisions.

"Some of the seven segments are profitable today, and others are expected to be profitable in the future," the representative said.

New organization
Microsoft's first-quarter results reflect a recent reorganization of the company's business units, with some groups breaking out revenue and profits for the first time. Under the old structure, Microsoft reported revenue for desktop applications, desktop operating systems, enterprise software, and other divisions. But the older organization of business units made it more difficult to discern the extent of operational weaknesses and strengths.

Under the new structure, Microsoft reports revenue and profits 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 refers to the online network and access services; Home & Entertainment includes the Xbox game console, consumer hardware and software, PC online games, and TV technology; 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.

Microsoft's money machine
The software company's operating system software and Office productivity suite account for almost all its profits in the first quarter.

Unit Revenue Profit/(Loss)
  Client*

    $2.89 billion     $2.48 billion  
  Information Worker**

    $2.39 billion     $1.88 billion  
  Server Platforms

    $1.52 billion     $519 million  
  MSN

    $531 million     ($97 million)  
  Home and Entertainment

    $505 million     ($177 million)  
  Business Solutions

    $107 million     ($68 million)  
  CE/Mobility Group

    $$17 million     ($33 million)  
  Total

    $7.74 billion     $4.05 billion  
* Includes Windows OS  ** Includes Office

For the first quarter, the Client, Information Worker and Server Platforms groups pulled in profits of $4.88 billion. The two desktop groups--Client and Information Worker--brought in $4.36 billion in profits.

"Windows and Office still remain the cash cows," Silver said. "This shows why Microsoft is afraid of Linux and StarOffice--because they threaten these cash cows and the means of expanding into new business opportunities."

By contrast, MSN lost $97 million on $531 million in revenue; Home and Entertainment lost $177 million on $505 million in sales; and Business Solutions lost $68 million on $107 million in sales. The CE/Mobility Group, which includes Pocket PC and Microsoft cell phone software racked up $33 million in losses on sales of $17 million.

Still, some of Microsoft's loss leaders showed improvements. During the same period a year earlier, MSN losses reached $199 million on revenue of $431 million; Home and Entertainment lost $39 million on $74 million in sales; Business Solution losses topped $68 million on sales of $236 million; and the CE/Mobility Group lost $48 million on $14 million in revenue.

For the first quarter, the four money-losing business units combined accounted for $1.16 billion of Microsoft's $7.74 billion in revenue, or about 15 percent. But the groups only sapped Microsoft profits by about 8 percent.

Windows tops Office
The more startling statistic may be the continuing trend of Windows becoming more important to Microsoft revenue and profit than Office. During the first quarter, the Client--or desktop Windows--group accounted for 37 percent of revenue and 61 percent of profits after factoring in losses from four other divisions. Information Worker, which is largely made up of Office, accounted for 30 percent of revenue and 46 percent of profits. (Losses in other groups allow profit figures here to add up to more than 100 percent.)

A year earlier, the Client group represented 34 percent of revenue and 58 percent of profits compared with the Information Worker unit's 31 percent of revenue and 51 percent of profits.

"Windows is again a bigger part of the income component than Office," Silver said. "This is a significant change from a few years ago when Microsoft derived most of its profits from Office."

Silver noted that both products benefit from two advantages: huge market share in their respective categories and recent changes to how Microsoft licenses software.

In August, Microsoft fully enacted its Licensing 6 program, where customers pay up front annually under two or three contracts for discounted upgrades. Gartner estimates the plan raised the majority of customer fees anywhere from 33 percent to 107 percent. The program affects Office and Windows more than most other Microsoft products, analysts say.

One telling statistic may shed light on how Microsoft fairs in markets where it does not control huge market share. Profit margins for desktop versions of Windows came in shy of 86 percent, according to the 10-Q. That's up from about 82 percent during the same period a year earlier. Office profit margins were 78 percent in the first quarter compared with 76 percent a year earlier. Licensing 6 likely contributed to the profit-margin gains, analysts say.

By contrast, Windows Server, which according to IDC held less than 50 percent server market share in 2001, had 34 percent profit margins. A year earlier, Windows Server profit margins topped 26 percent.

 

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