Microsoft earnings paint mixed picture

The software giant said it earned $2.69 billion, or 25 cents per share, on revenue of $9.29 billion for the three months ended June 30. That compares to earnings of $1.48 billion, or 14 cents per share, on revenue of $8.07 billion for the same quarter a year ago.

Microsoft said the earnings included 5 cents per share of stock-related expenses and a 2-cent-per share tax benefit, while the company's year-ago earnings were dented by the costs of its $750 million settlement with Time Warner.

Excluding the tax benefit and compensation charges, Microsoft had earnings of 28 cents per share. Analysts were expecting the company to post 29 cents in per-share earnings, according to Thomson First Call, while Microsoft itself had forecast per-share earnings of 28 cents in April. Revenue of $9.29 billion was well ahead of the $9 billion that analysts had been expecting, and the $8.9 billion to $9 billion that Microsoft forecast in April.

In after-hours trading following the earnings report, Microsoft shares dipped to $28.09, down 91 cents, or more than 3 percent. Ahead of the report, the company's shares had risen narrowly, closing the regular session at $29, up 14 cents from Wednesday.

"We had a great quarter, with 15 percent revenue growth, as all of our businesses met or exceeded our expectations, and our progress on cost efficacy delivered higher operating margins overall," Microsoft CFO John Connors said in a statement.

In addition to benefiting from strong PC sales and improved MSN advertising sales, Microsoft's revenue was boosted by a relatively weak dollar. The company said the impact of foreign currency rates contributed to about 3 percent growth in its total revenue.

For the current quarter, Microsoft said to expect revenue of $8.9 billion to $9 billion, with earnings per share of 25 cents, including about 5 cents per share in stock-based compensation expenses.

Microsoft hiked its revenue expectations for the coming fiscal year but cut its expectations for per-share earnings. The company said it now expects revenue of between $38.4 billion to $38.8 billion and earnings per share between $1.05 and $1.08, including 16 cents of stock-based compensation expenses.

Connors said the higher revenue outlook stems from higher-than-anticipated signing of long-term contracts in the prior quarter as well as an improved forecast for Xbox sales. The lower earnings figure is largely due to decreased investment income as Microsoft proceeds with its cash disbursement plans.

In April, the company had forecast revenue in the range of $37.8 billion and $38.2 billion and per-share earnings of between $1.16 and $1.18, including stock-based compensation expenses of about 15 cents per share.

Of course, the big news came on Tuesday, when Microsoft unveiled a plan to return $75 billion to shareholders through the combination of a stock buyback, an increased dividend and a one-time payout of $32 billion.

Microsoft said its balance of cash and short-term investments rose to $60.6 billion during the quarter, up from $56.4 billion at the end of March.

Breaking down the math
Microsoft's balance of unearned revenue at the end of the quarter was $8.18 billion, up $651 million from March, spurred by an increase in new multiyear licenses and renewals. Microsoft watchers study this figure closely to try to estimate what the company's prospects are for future quarters.

The result was better than expected. Microsoft was able to convince more customers of its expiring Upgrade Assurance program to sign new types of long-term agreements. The company had said it expected only 10 percent to 30 percent of such customers to sign new pacts.

"So far we are tracking to the high end of that range," Connors said in a conference call with analysts. Microsoft said it expects its balance of unearned revenue to dip by $200 million to $300 million during the current quarter because of seasonal factors, but predicted by the end of the fiscal year next June it will grow to more than $8.6 billion.

Looking at the results for Microsoft's seven business units, the client unit, which includes desktop and notebook versions of Windows, saw revenue of $2.75 billion, up 9 percent, as operating income increased 10 percent to $2.06 billion.

The Server and Tools unit, which includes Windows Server 2003 and other server software, generated $2.3 billion in revenue--up 20 percent--and $567 million in operating income, up 85 percent. The unit saw a 19 percent increase in Windows-based server shipments and got an additional boost from foreign currency exchange.

The Information Worker unit, which includes Office, posted $2.88 billion in revenue, up 23 percent, and $1.96 billion in profit, up 33 percent.

Microsoft's Business Solutions unit, which includes its Navision and Great Plains lines, narrowed its operating loss to $42 million from $73 million a year ago, as sales increased 9 percent to $196 million. The Mobile and Embedded Devices unit, which includes Windows CE-based products, grew sales 59 percent, to $70 million, and narrowed its operating loss to $42 million from $68 million a year ago.

MSN, which just completed its first profitable year, posted a $35 million quarterly profit on $588 million in revenue. That compares to a loss of $83 million on revenue of $559 in the year-ago quarter.

The Home and Entertainment unit, which includes Xbox, was the only unit to see its quarterly loss widen, growing to $339 million from $245 million a year ago. Sales increased 3 percent, to reach $499 million.

Investing in Xbox
Microsoft separately reported that total Xbox sales are now up to 15.5 million units since the console's launch three years ago, at the high end of company estimates. Xbox continued to gain market share in North America, now accounting for a third of the market. Globally and in North America, that market continues to be dominated by Sony's PlayStation 2.

Robbie Bach, senior vice president in Microsoft's Xbox division, attributed the gains to a strong selection of games, a recent price cut and growing support for the Xbox Live online gaming service, which recently hit 1 million subscribers.

Microsoft expects to ship another 5 million Xbox units during the new fiscal year. Upcoming releases of several high-profile games--including the November launch of the sequel to all-time Xbox top-seller "Halo"--are expected to buoy sales.

"What you have to factor in is how much of a cultural phenomenon 'Halo 2' will become," Bach said. "It's our belief this is going to be one of those entertainment properties that get out into the marketplace in a broad way."

The earnings report also highlights Microsoft's continuing subsidizing of Xbox hardware, a situation Bach said nobody's in a hurry to change. "We've been in an investment mode, where we sell consoles at a loss," he said. "We can be profitable soon if we want to, but we'd have to slow the rate of customer acquisition down a bit, and that is not the way we want to go now."