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Microsoft beats earnings expectations

The Redmond, Wash.-based software giant beats fiscal 2003 third-quarter projections by 2 cents a share and raises expectations for the full year.

Microsoft beat Wall Street expectations Tuesday, chugging ahead despite a weak economy and slow technology spending.

The Redmond, Wash.-based software giant reported third-quarter earnings of $2.79 billion, or 26 cents a share, compared with $2.74 billion, or 50 cents a share, a year earlier. In January,

Revenue rose 8 percent to $7.84 billion, from $7.25 billion a year earlier. Sequentially, sales declined from $8.54 billion in the fiscal second quarter. The company said operating income was up 13 percent, to $3.72 billion from $3.3 billion a year ago.

A consensus of analysts polled by First Call anticipated earnings of 24 cents per share on revenue of between $7.7 billion to $7.8 billion, and operating income between $3.4 billion and $3.5 billion.

Microsoft announced earnings on a Tuesday rather than its usual Thursday to accommodate people celebrating the Passover holiday, according to a company representative. Microsoft's third fiscal quarter closed March 31.

In a statement issued Tuesday, John Connors, Microsoft's chief financial officer, set a cautious but optimistic tone for the company's fourth quarter and for fiscal 2003, which ends June 30.

"We reported another quarter of strong revenue and operating income results in a very tough environment," Connors said. He positioned new enterprise products, due for release in the next six months, to bring in the capital that the company needs to rise above hard times. "We believe that these innovative products will enable our customers to get more productivity and value out of their information technology investments," he said.

Connors also set expectations for fiscal 2004 and issued guidance for the fourth quarter, for which Microsoft expects revenue to be between $7.8 billion and $7.9 billion, operating income to be between $3.1 billion and $3.2 billion and earnings per share to be either 23 cents or 24 cents. For fiscal 2004, Microsoft projects revenue between $33.1 billion and $33.8 billion, operating income between $14.8 billion and $15.1 billion and earnings per share between $1.04 and $1.06.

Unearned revenue's impact
As in previous quarters, Microsoft resisted the downward pull of the economy by way of unearned revenue, which is revenue for software that has yet to be delivered. Unearned revenue accounted for about 26 percent of the company's total revenue during the third quarter, compared with 22 percent of revenue in the second quarter and 23 percent in the first quarter.

Money collected through Microsoft's Licensing 6 program is counted as unearned revenue. In May 2001, the software company announced the program, under which companies pay up front for products under two-year or three-year "Software Assurance" contracts. The program met with stiff customer resistance for removing the choice of when to upgrade and for raising licensing fees from 33 percent to 107 percent, according to research firm Gartner. Microsoft completed the transition to Licensing 6 on Aug. 1.

A last-minute sign-up spree for Licensing 6 led to a huge spike in Microsoft's unearned revenue during the last part of fiscal 2002 and the start of the new fiscal year. During the first quarter, unearned revenue swelled to $9.13 billion, mostly from licensing, up from $5.85 billion a year earlier. The company ended the second quarter with $8.83 billion in unearned revenue.

But as Microsoft begins to realize unearned revenue on the balance sheet, the big boost is starting to level out.

"We expect that deferred revenue will continue to show a decline for the next couple of quarters before the company can begin rebuilding its unearned revenue balance," Merrill Lynch Jason Maynard wrote in a Tuesday research note.

Unearned revenue declined $304 million from the second quarter to the third, according to Microsoft. The company closed the third quarter with $8.53 billion in unearned revenue. It expects to realize $2.55 billion in the fourth quarter, $1.94 billion in the first quarter of fiscal 2004, $1.4 billion in the second quarter, $916 million in the third quarter and $1.73 billion in the last quarter.

The earliest wave of Licensing 6 participants won't be ready to sign up again, assuming that they choose to do so, until Oct. 31.

"This the first date on which Software Assurance will begin to expire," said Paul DeGroot, an analyst with market researcher Directions on Microsoft. "This would be for customers who bought SA?as soon as SA was available, on Oct. 1, 2001."

Still, Microsoft is getting ready to release many new products over the next two to three quarters, which could help boost revenue. But many of the products are focused on the enterprise, where adoption tends to take place at a slower rate.

The products to be launched this year include: , scheduled for April 24 release; Office 2003; Exchange Server 2003; Windows Rights Management Services (RMS); and Real-Time Communications Server 2003.

But many interdependencies between products means "that if one slips past the ship date, others will, too," DeGroot said. For example, Office relies on features in Exchange and RMS. A delay of RMS could affect Office, while an Office delay could hold up Exchange.

Segment results
Third-quarter revenue for Microsoft's Client group, which covers desktop and embedded operating systems, was $2.54 billion, compared with $2.3 billion a year earlier and $2.55 billion in the second quarter.

The Information Worker division, which handles Office and other desktop productivity software, saw sales rise 9 percent to $2.33 billion from a year earlier. The group reported $2.29 billion in the second quarter.

The online unit MSN posted revenue that rose to $508 million, compared with $404 million a year earlier and $459 million in the second quarter. MSN subscription revenue rose 9 percent and paid services--largely from paid search and ads--rose 55 percent.

Revenue for Microsoft's Home and Entertainment division, which looks after the Xbox game console, declined 42 percent to $453 million, from $778 million a year earlier. (Second-quarter revenue topped $1.33 billion.) Lower Xbox sales largely contributed to the dramatic decrease in revenue.

CE/Mobility posted sales of $38 million, up from $21 million a year earlier.

Sales of Server Platforms reached $1.83 billion, up 21 percent year over year. During the second quarter, revenue reached $1.76 billion.

Business Solutions, which covers Great Plains and bCentral, reported a third-quarter revenue of $147 million, compared with $75 million a year earlier and $135 million in the second quarter.