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Legal Expenses Take Bite Out Of Microsoft's Earnings 2

Third-quarter earnings fell 38% as the company was hit by big charges related to legal matters and for expenses related to stock-based compensation.
Microsoft reported a 38% drop in third-quarter profits Thursday, as charges related to its antitrust troubles dragged down earnings. The world's largest software company also reported another sequential decline in its unearned revenue account, indicating customers may be waiting for new products several years out before they sign multiyear license agreements with built-in upgrade triggers.

For the quarter ended March 31, Microsoft reported net income of $1.32 billion, or 12 cents per share, compared with $2.14 billion, or 20 cents per share, during the same quarter a year ago. Sapping profits were a $501 million expense for stock compensation, a $1.89 billion charge related to its settlement of an antitrust dispute with Sun Microsystems, and a $605 million fine by the European Commission. Excluding the legal charges, Microsoft said it would have turned a profit of 34 cents a share, ahead of the 29 cents per share expected by analysts polled by Thomson First Call.

Revenue for the quarter increased 17%, to $9.18 billion, from $7.84 billion a year ago. Sales of Windows, Office, database and E-mail software, and software development tools combined for 17% year-over-year growth. In addition, IT spending by companies improved during the quarter, and CFO John Connors said the company expects "healthy demand" for its products through the June 30 end of Microsoft's fiscal year.

"We are in the midst of a corporate recovery," Connors said during a conference call with analysts. "Corporate profits are up, and businesses seem more willing to invest in IT projects." The company's Office 2003 suite, for example, sold double the amount of its predecessor, Office XP, during each product's first five months on the shelf.

But Microsoft is still trying to convert business customers to its newest products and get them to sign long-term license agreements with additional upgrade rights, called Software Assurance. Microsoft's unearned-revenue account, which reflects revenue from multiyear contacts that the company hasn't yet booked, declined by $326 million sequentially during the third quarter, indicating customers aren't renewing long-term deals as quickly as they once did. The account declined for the third consecutive quarter, and Connors said he expects a continued decrease. But the decline was less than the $600 million sequential decline forecast by Lehman Brothers, according to a research note from analyst Neil Herman.

The next version of Windows, code-named Longhorn, isn't due until at least 2006, and new versions of its SQL Server database and Visual Studio development tools won't ship until next year.

Microsoft has received a revenue boost from shorter-term upgrade contracts signed before its new licensing rules went into effect, but virtually all of the revenue from that program is expected to be recognized by the end of the current fiscal year.

For the fourth quarter, Microsoft said it expects to report revenue of between $8.9 billion and $9 billion and earn 23 cents per share. For the 2005 fiscal year, the company expects revenue of between $37.8 billion to $38.2 billion and earnings between $1.16 and $1.18 per share. That would be a historically low revenue growth rate of about 7%.

Also in question is what Microsoft plans to do with its more than $50 billion in cash. The company has been using the cash to settle lawsuits with companies including Sun, Time Warner's AOL unit, and Intertrust Technologies, as well as class-action lawsuits by U.S. states. Connors said Microsoft will disclose more information about plans for its cash at its annual meeting with financial analysts in July.