Microsoft: Billions Up, a Penny Short?

Microsoft’s profit for its fiscal fourth quarter
jumped by 82 percent to $2.69 billion (25 cents per share), thanks to a tax
benefit, but it missed analysts expectations by a penny.

Revenues for the software giant were $9.29 billion for the quarter ended
June 30, 2004, a 15 percent increase over the same period last year.

“A great quarter closed a terrific year,” Microsoft CFO John Connors told financial analysts. “All of our seven business are growing and providing an aggregated 14 percent growth for the year.”

Operating income for the fourth quarter was $3.13 billion, including a
pre-tax stock-based compensation expense of $739 million, more than doubling
year over year, although the same quarter last year took a double whammy
with a stock-based compensation expense of $665 million (pre-tax) and
charges of $796 million (pre-tax) primarily related to the settlement of the
Time Warner lawsuit.

Net income for the fourth quarter was $2.69 billion, including a $208
million tax benefit, up from the $1.48 billion reported in the same quarter
last year. Diluted earnings per share for the quarter were 25 cents,
compared to 14 in the fourth quarter of the previous fiscal year.

The Server and Tools division grew 20 percent year-over-year. Revenues
from its Information Worker division grew 23 percent, and its MSN division
completed its first-ever profitable year.

The results closed the books on the company’s full fiscal year at
revenues of $36.8 billion, up 14 percent over the previous year. Microsoft’s
profit for the year was $8.17 billion (75 cents per share), up 8.4 percent
over last year’s net income of $7.53 billion (69 cents per share).

The company said EPS included charges for stock compensation, as well as
charges related to the Sun Microsystems settlement and a fine imposed by the
European Commission over its ruling that Microsoft violated EU antitrust
law, which Microsoft is appealing.

Looking ahead, Microsoft said it expected revenue in its first fiscal
quarter ending September 30, 2004, would be in the range of $8.9 billion to
$9 billion.

In a conference call, analysts questioned Connors closely about unearned revenue, the revenue that Microsoft expects from renewals in software licenses. Currently, Microsoft offers its Software Assurance program, which lets customers upgrade products as new versions came out. A previous version was known as Microsoft’s Upgrade Advantage program.

While June 2004 saw strong enterprise renewals, Connors said, “I think we have appropriately modest expectations for renewal of upgrade advantage in Q1.”

He said Microsoft hasn’t changed its projection of about a 10 to 30 percent renewal rate of expiring Update Advantage contracts. Upgrade Advantage customers were typically license-only, Connors said, and it’s unlike that most of them won’t be interested in the multi-year Software Assurance program.

Connors warned that unearned income would be seasonal, with strong billings for the quarters ending in June and December 2005, with the other two quarters declining. On the whole, Redmond expects the unearned revenue balance to grow to over $8.6 billion by year-end.

“We feel good about the value we’re returning to shareholders, while investing in growth opportunities and continuing to have enough cash in future,” Connors said.

Melanie Hollands, a stock analyst and president of the Koala Capital
hedge fund, pointed out that, while Redmond is sitting on a mountain of
money, an investor who bought the stock in early 2000 would find this
investment worth less than half its original purchase price. At the
beginning of 2000, Microsoft was trading at around $60. Five years later,
the stock had more than halved.

“So, an investor who bought Microsoft in mid-to-late 2002 would have
enjoyed no capital appreciation from that investment and may, in fact, have
lost money depending on when and in what part of the trading range they
purchased the stock,” Hollands said.

Connors told analysts, “We’re very focused on managing our costs.” Overall costs will come down $5 billion in 2005.

Microsoft trimmed its employee benefits this quarter, not without plenty
of soul-searching, according to an e-mail CEO Steve Ballmer sent to employees
earlier this month. Even with the cuts, Ballmer wrote, the cost of benefits
per employee will rise 6 percent next year, in part due to skyrocketing
health-care costs.

“We considered and rejected more substantial changes based on employee
input, the value we know benefits have to employees, the importance of
maintaining employee productivity, and preserving our great culture,”
Ballmer wrote.

While some Microsofties wondered why the company couldn’t spend some of
that $56 billion in cash on preserving benefits, Ballmer told them, “Using
the cash reduces profits, which reduces the stock price. The cash is
shareholders’ money, so we need to either invest in new opportunities or
return it to them.”

On Tuesday, the company made its choice,
returning a huge wad of cash in the form of a one-time $3 dividend, to be paid in the second quarter of the fiscal year, and a $30
billion stock buyback plan. The software giant also doubled its annual
dividend to 32 cents a share. In all, it plans to share about $75 billion
with shareholders over the next four years.

Despite the recent tech stock downturn, Forrester Research remains
relatively bullish about IT spending for the rest of the year. Last month,
it raised its 2004 US IT spending forecast to 6 percent growth over 2003
levels, reflecting the first quarter’s stronger-than-expected spending on
computers and software.

Forrester’s Q2 CIO Confidence Poll also found an uptick in IT spending:
55 percent of the CIOs surveyed expect spending to remain on budget during
the next three quarters, and another 34 percent expect to outspend their
budgets, up from 25 percent in the previous quarter.

Forrester had especially good news for Microsoft: It predicts that
spending on purchased software will grow by 10 percent in 2004. The company
said that operating system and storage software is growing more slowly than
hardware, and software prices will continue to face pressure, but their rate
of decline will slow.

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