Microsoft Q3 revenue up but legal expenses bite into profit

Microsoft Thursday reported strong sales of its server software, client operating systems and Office application but said that stock compensation and legal settlements paid during its fiscal third quarter contributed to a 38% drop in quarterly profits.

Microsoft (MSFT) Thursday reported strong sales of its server software, client operating systems and Office application but said that stock compensation and legal settlements paid during its fiscal third quarter contributed to a 38% drop in quarterly profits.

The company said its settlement of legal proceedings with Sun and a fine imposed by the European Commission resulted in a 38% decline in profit for the quarter ended March 31, 2004 compared to the same quarter a year ago. Profit for fiscal third quarter 2004 was $1.32 billion, which included a pre-tax stock-based compensation expense of $748 million and legal charges of $2.53 billion. Profit in the same quarter a year ago was reported at $2.14 billion.

Microsoft reported revenue of $9.18 billion, a 17% increase over $7.84 billion in the prior year.

The company said increased licensing of client and server operating systems through OEMs, Office 2003, and server products including Exchange and SQL Server drove revenue gains. The company also noted improved MSN advertising revenue.

“Last quarter, we said that we were beginning to see evidence of an improvement in the corporate IT market. Our results this quarter demonstrate that we are in the midst of a corporate recovery,” said Microsoft CFO John Connors.

Sales in Microsoft’s Client, Information Worker and Server and Tools business units grew a combined 17%, the company said. In an earnings report, Goldman Sachs said the numbers indicate that Linux appears to be having no negative effects on Microsoft’s desktop or server business.

Microsoft also may be seeing some positive signs as it tries to convince customers with expiring contracts to sign up for its new licensing program, Software Assurance.

The company reported a $326 million drop in unearned revenue, which is revenue from licensing contracts that is recorded over multiple quarters. The drop was less than what some analysts predicted, which may indicate that Microsoft is getting some customers with expiring Upgrade Advantage contracts to sign on to Software Assurance.  

But Connors did say that because of $1.1 billion in unearned revenue collected from Upgrade Advantage contracts in fiscal year 2004, which won’t be matched in fiscal year 2005, that the company would be left with tough comparison numbers between the two years in the Information Worker and Server Tools business units. The statement may provide an indication that Microsoft is having the greatest trouble securing licensing renewals for Office and Windows server, both of which won’t have new versions until 2006 or 2007.

“The key thing is that we have to get a great value message out and we think with the products we have and the roadmap we’ve got, we’ve got a pretty compelling value proposition,” said Connors in reference to the challenge of licensing renewals.

Microsoft’s enthusiasm for the quarter results partially focused on its Information Worker business unit, which grew 18% in the fiscal third quarter over the prior year. The company attributed the rise to strong sales of Office among all its customers, including corporate customers such as Circuit City, Del Monte Foods, Perot Systems, The Thomson Corporation, and Unisys.

Microsoft also reported that OEM licensing revenue for Office 2003 grew 35% compared to the prior year’s third quarter.  The increase in revenue, however, was partially attributable to previously deferred multi-year licensing arrangements revenue, including Upgrade Advantage contracts.

The Client business unit, which includes the Windows operating system, showed an 18% growth in OEM licenses compared to a year ago. Microsoft also reported that unit shipments of the Professional version of the platform were up 2% to 58% of the total Windows licenses compared to a year ago.

In the Server and Tools business unit, revenue was $445 million driven by demand for Exchange, SQL Server and Visual Studio. Microsoft said new licenses for Windows Server grew by 31%.

The outlook was not so rosy in the Business Solutions unit even though Microsoft reported that net losses had dropped 29% over the previous quarter a year ago. Overall revenue was up 4%, but Connors admitted that licensing of Navision and Axapta products was still slow within the U.S., meaning Microsoft continues to have trouble penetrating one of its key markets.

Microsoft also predicted that fiscal fourth quarter revenue would be in the range of $8.9 billion and $9.0 billion. The company also announced predictions for revenue in fiscal year 2005, which ends June 30, 2005, at between $37.8 billion and $38.2 billion.