July 18, 2002 2:00 PM PDT

Software sales propel Microsoft gains

Microsoft's revenue rose 10 percent in the fourth quarter, thanks in part to increased sales of Windows XP and a new, somewhat controversial corporate licensing plan.

The Redmond, Wash.-based company reported earnings Thursday of $1.53 billion, or 28 cents a share, compared with $66 million, or 1 cent a share a year earlier. For fiscal 2002, Microsoft earned $7.83 billion, or $1.41 a share, compared to $11.72 billion, or $1.32 per share, a year earlier. Both periods ended June 30.

Excluding a $806 million charge to cover investment impairment, Microsoft would have posted earnings of $2.87 billion, or 43 cents a share, for the quarter and $11.91 billion, or $1.94 per share, for the year.

A consensus of analysts polled by First Call anticipated earnings of 42 cents per share for the fourth quarter and $1.83 per share for the year.

Fourth-quarter revenue grew 10 percent to $7.25 billion, up from $6.58 billion a year earlier. For the year, sales topped $28.37 billion, up from $25.3 billion in 2001.

Analysts had expected fourth-quarter revenue to be around $7.06 billion and $28.25 billion for the year. In April, Microsoft projected quarterly revenue between $7 billion and $7.1 billion, and $28.1 billion to $28.2 billion for the year.

During a conference call with financial analysts, Microsoft Chief Financial Officer John Connors credited the quarterly success as well as the year's success to strong sales of Windows XP, Xbox, MSN and server products.

Despite "weak PC demand and corporate IT spending, Microsoft was able to deliver extremely solid operating results from a revenue and operating profits statement," he said.

As expected, Microsoft offered new guidance for the first quarter and fiscal 2003, both which started on July 1. The company projects revenue between $7 billion and $7.1 billion, with earnings of around 41 to 42 cents per share.

For the year, Microsoft estimates revenue would be between $31.4 billion and $32 billion, with earnings per share in the $1.85 to $1.91 range. In April, the software titan projected revenue of between $31.5 billion and $32.4 billion and earnings of $1.89 to $1.92 per share for fiscal 2003.

Despite the weak economy, some analysts remain bullish on Microsoft as it enters fiscal 2003.

"Our EPS (earnings per share) estimate of $2.04 is well above company guidance and the consensus estimate of $1.92 based on our assessment of the (fiscal year 2003) impact of the current upgrade cycle and pricing changes, the timing of an IT spending recovery and the strength of Microsoft's .Net Web services strategy," Bernstein analyst Charles Di Bona wrote in a Wednesday research note.

During fiscal 2003, Microsoft is expected to release many important software upgrades and major building blocks for its Web services strategy, including the expected release of .Net Server, Windows Media 9 Series Edition, Exchange Server, Windows Media Center Edition and Tablet PC.

In another Wednesday research note, Merrill Lynch analyst Christopher Shilakes expressed cautious optimism about fiscal 2003. Both Shilakes and Di Bona predicted Microsoft's stock could reach $65 within 12 months.

Di Bona noted Microsoft "is currently trading at or near its lowest levels in the past 10 years."

Microsoft shares on Thursday fell 89 cents, or 1.7 percent, to $51.11, before the earnings report was announced.

Licensing changes windfall
As expected, a last-minute spending spree by larger businesses buoyed the current quarter and greatly added to the amount of unearned revenue on Microsoft's balance sheet. Microsoft entered the quarter with about two-thirds of eligible companies waiting to sign onto a controversial new licensing program ahead of an important July 31 deadline.

Microsoft closed the quarter with unearned revenue of $7.74 billion, compared with $5.61 billion a year earlier. Unearned revenue is revenue that is secured through contract but not yet received.

Unearned revenue for desktop applications, such as Office, was $3.49 billion compared with $2.19 billion a year ago. PC versions of Windows unearned revenue rose to $3.20 billion from $2.59 billion year over year.

Under the new program, companies must sign up for a two- to three-year "Software Assurance" maintenance program to continue receiving discounted upgrades. But in the process, Microsoft also eliminated the most popular means of buying licenses, effectively raising rates between 33 and 107 percent, according to market researcher Gartner.

In anticipation of last-minute sign-ups, which would carry additional revenue benefit over into the first month of Microsoft's fiscal year 2003, some analysts had predicted fourth-quarter earnings as high as 46 cents a share.

The majority of unearned revenue comes from software licensing, but not all. Microsoft also includes undelivered items, such as technical support in the mix. This later category, for example, accounts for 20 to 25 percent of the Windows XP Home unearned revenue and 10 to 15 percent each for Windows XP Professional and desktop applications.

"Growth in unearned revenue on the balance sheet was very strong, up 38 percent year over year and $830 million sequentially, reflecting the large number of annuity agreements signed during the quarter," Scott Boggs, Microsoft's corporate controller.

Microsoft's corporate controller predicted $6 billion of the $7.74 billion in unearned revenue would be realized next year. For the current quarter, recognition of previously deferred licensing income accounted for 20 percent of fourth-quarter revenue.

"Unearned revenue for the enterprise software and services business was up an eye-popping 102 percent over last year, as more customers took the opportunity to include more server products in their annuity licenses," Boggs said. The year-over-year increase for desktop applications was 59 percent.

But the long-term impact of the licensing program remains uncertain, with at least one-third of eligible customers refusing to sign on to the new program. On Tuesday, Jeff Parker, president and co-founder of research firm Directions on Microsoft, warned Microsoft could face trouble ahead.

"Software Assurance could boost Microsoft's bottom line in the short run, as customers rush to get into the program on favorable terms by July 31," he said. "But a crunch may come two to three years from now, when the bulk of Software Assurance memberships begin to expire, if customers feel they didn't get their money's worth and decide not to renew."

In a broader context, some analysts charge the licensing rate hikes, which affected a disproportionately large number of businesses because of massive Windows and Office market share, may have hurt new computer sales.

Microsoft's "complex new licensing agreements (July 31) deadline have also contributed to stalling PC demand," said U.S. Bancorp Piper Jaffray analyst Ashok Kumar. "Domestically, demand appears stable though CIOs remain focused on reducing cash burn."

PC shipments dropped slightly for the second quarter, marking the fifth-consecutive quarterly decline, IDC revealed on Thursday.

Segments a mixed bag
Internationally, the South Pacific and the Americas accounted for $2.98 billion in sales compared with $2.66 billion a year ago and $2.76 billion in the third quarter; regional sales rose 12 percent year over year. Revenue for Europe, the Middle East and Africa was $1.22 billion, compared with $1.15 billion a year earlier and $1.39 billion in the third quarter. Asia saw revenue fall 9 percent to $704 million from $777 million in fourth quarter of 2001; sales were $818 million in the previous quarter.

Original equipment manufacturer (OEM) revenue reached $2.34 billion compared with $2 billion a year earlier and the third quarter's $2.29 billion.

Combined revenue for desktop and server software and services revenue rose 8 percent to $5.84 billion from $6.32 billion a year earlier. Revenue for the segment topped $6 billion in the third quarter.

Desktop application revenue reached $2.52 billion, up from $2.51 billion a year earlier and $2.44 billion sequentially.

Windows desktop sales topped $2.44 billion, up 20 percent from $2.04 billion a year earlier; revenue was $2.29 billion in the third quarter. Higher sales of Windows 2000 and Windows XP Professional greatly contributed to the sales increase.

Enterprise software sales reached $1.35 billion, up from $1.29 billion year over year and from $1.28 billion sequentially.

Sales in the consumer software, services and devices group, which includes Internet access, online services and the Xbox game console, rose to $822 million from $509 million a year earlier.

Revenue from consumer commerce investments, which includes HomeAdvisor and CarPoint, reached $13 million, compared to $96 million a year earlier and $45 million in the third quarter.

 

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