Microsoft beats forecasts, but legal costs hurt

The software behemoth posts fiscal third-quarter revenue that's above expectations, but earnings are dented by the costs of a fine by the European Union and a settlement with Sun.

Microsoft reported on Thursday fiscal third-quarter revenue above expectations but saw its earnings dented by the costs of a fine by the European Union and its settlement with Sun Microsystems.

The software maker said it earned $1.32 billion, or 12 cents per share, on revenue of $9.18 billion, for the three months ended March 31. That compares with earnings of $2.14 billion, or 20 cents per share, on revenue of $7.84 billion in the same quarter a year earlier.

The results included stock-based compensation expenses that amounted to 5 cents per share and legal charges equaling 17 cents per share. Excluding those items, Microsoft would have had earnings of 34 cents per share, ahead of the 29 cent First Call estimate and the company's own predictions.

In January, Microsoft predicted per-share earnings of 23 cents or 24 cents, factoring in a charge of 5 cents for stock-based compensation expenses, with revenue expected to be between $8.6 billion and $8.7 billion.

"All of our businesses met or exceeded our expectations this quarter," Microsoft Chief Financial Officer John Connors said in a statement Thursday. "Overall corporate (information technology) spending continued to improve, and we expect to see healthy demand through the end of our fiscal year."

For the current quarter, which ends in June, Microsoft predicted earnings per share of about 23 cents, including 5 cents in stock-based compensation expenses, on revenue in the range of $8.9 billion to $9 billion. Those figures are roughly in line with what analysts had been expecting from the software maker.

The earnings report shows that Microsoft's legal issues are taking a toll on the bottom line, though the company has more than $50 billion in the bank. Last month the EU handed down a 497 million euro fine ($613 million at the time; $590 million at current exchange rates) against Microsoft, and the company has set aside a $605 million accrual for the fine that counted as a charge for the quarter.

In addition, Microsoft has paid out nearly $2 billion in accordance with a settlement earlier this month with Sun.

Microsoft also on Thursday offered guidance for the coming fiscal year, which ends in June 2005.

The company said to expect revenue in the range of $37.8 billion and $38.2 billion. Operating income is expected to be anywhere from $15.9 billion to $16.3 billion, including stock-based compensation expenses of approximately $2.5 billion. That's expected to amount to per-share earnings of between $1.16 and $1.18, including stock-based compensation expenses of approximately 15 cents per share.

Microsoft said its cash and short-term investment balance rose to $56.4 billion, up from nearly $53 billion in December and $49 billion a year earlier, and noted that its revenue for the quarter was boosted by the weak dollar. Had exchange rates been what they were a year ago, Microsoft said its revenue would have been $350 million lower.

Microsoft's balance of unearned revenue--that is, monies received as part of long-term contracts--declined $326 million from the prior quarter, in part because of a $248 million drop in unearned revenue from various volume license programs. Microsoft's unearned revenue balance is closely watched by analysts as a measure of gauging future results.

The company had cautioned that the balance would drop in the most recent quarter as it began phasing out an older Upgrade Advantage license program.

Individual units
As for its individual business units, Microsoft noted that it saw 17 percent growth in its three main ones, which include those responsible for desktop and server versions of Windows as well as the division that handles Office.

Microsoft said revenue in its client unit, which handles the desktop version of Windows, grew from $2.5 billion a year ago to $2.9 billion in the most recent quarter. The server and tools unit, which deals with Windows Server, saw sales rise to $2.2 billion from $1.8 billion a year earlier, while sales in the information worker unit, which oversees Office, grew to $2.7 billion from $2.3 billion in the year-ago quarter.

Among Microsoft's smaller units, MSN saw revenue increase to $591 million from $508 million a year ago. The home and entertainment unit, which includes the Xbox game console in its purview, saw sales hit $530 million, up from $453 million. The Microsoft Business Solutions unit, which sells business software largely to small and midsize companies, saw sales inch up to $153 million from $147 million a year ago. The mobile and embedded unit, which handles sales of Windows Mobile for handhelds and smart phones, saw sales increase to $61 million from $46 million a year earlier.

Microsoft also broke out the profitability of its individual business segments on the day of its earnings. The company often releases such information later, as part of its formal filing with the Securities and Exchange Commission.

Microsoft noted that operating income in its client unit fell 16 percent, to $1.6 billion, even though sales rose by a similar percentage, with the drop largely attributed to $700 million in costs associated with the Sun settlement. The server and tools unit also took a hit, stung by $1.22 billion in legal expenses, posting a $635 million operating loss. The information worker unit, which was not hit by legal charges, saw operating income rise 14 percent, to $1.9 billion.

The business solutions unit narrowed its operating loss to $65 million from $92 million a year earlier. MSN posted a $107 million profit, a reversal of a $139 million loss a year earlier, as a 43 percent increase in advertising revenue more than offset a decline in subscription revenue.

The mobile unit narrowed its loss, from $72 million a year earlier to $38 million. The home and entertainment unit also posted a narrower loss--$209 million as compared with $277 million a year earlier.

Microsoft shares were up 5.6 percent, or $1.45 per share, to $27.40 in after-hours trading. Shares of the software giant were also up during the day, closing nearly 2 percent, or 50 cents per share, higher at $25.95.

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