Microsoft's 2Q Revenue Rises; Profits Drop Due To Stock Charge

Revenue rose 19% to $10.15 billion, but a $2.17 billion charge for stock-based compensation for employees left earnings below the year-ago quarter.
Microsoft's second-quarter revenue rose 19% on the strength of robust PC sales, and the company raised its revenue estimate for the year, but a big charge for compensating employees with stock sent earnings lower by 17%.

For the quarter ended Dec. 31, Microsoft reported net income of $1.55 billion, or 14 cents a share, down from $1.9 billion in the same quarter last year. Revenue came in at $10.15 billion, the first time Microsoft has topped $10 billion in a quarter. Strong consumer demand for PCs and more technology spending by businesses lifted revenue figures, CFO John Connors said during a conference call with investors Thursday after the results were released. Sales of Windows and Office helped power the gains.

Microsoft estimated that PC shipments rose 12% during the quarter and forecast low-double-digit growth for its 2004 fiscal year, which ends in June. When the company reported first-quarter results in October, it figured only a high-single-digit rise. Server shipments also topped Microsoft's forecast, Connors said. As a result, sales of desktop Windows, "information worker" software--mostly Office--and server software and development tools all rose by more than 20%. IT spending by businesses should continue to improve in the second half, Connors added.

Microsoft also raised its revenue estimate for 2004 to between $35.6 billion and $35.9 billion, an 11% to 12% increase over 2003. Previously, Microsoft had forecast an 8% to 10% increase.

But Microsoft's net income during the quarter was drained by a $2.17 billion, 20 cent-per-share expense for compensating employees with shares of stock. Late last year, Microsoft completed a program announced in July under which employees could sell their Microsoft stock options and move to a compensation system built on awards of company stock. Without the charge, Microsoft would have reported earnings of 34 cents per share. Wall Street analysts had expected Microsoft to earn 30 cents per share on revenue of $9.7 billion.

What raised the most questions among investors, though, was another drop in Microsoft's unearned revenue account, which reflects quarterly bookings of long-term software contracts signed by companies. The account declined sequentially from the first quarter by $395 million, to $7.85 billion on Dec. 31. Atop an unexpectedly sharp $768 million drop during the first quarter which ended Sept. 30, the decline indicated that businesses may not be renewing long-term licensing deals as quickly as they once did. Microsoft attributed the steep first-quarter decline to a sales-force reorganization and the effect of computer virus outbreaks on customers' confidence, and Connors today said there's still a large group of customers buying licenses without Software Assurance, a type of contract that charges annual fees for the right to unlimited upgrades. Microsoft has been pushing the contracts as a way to boost revenue.

"The real question for us is, what percentage of license-only customers will move to annuities?" Connors said.

Lehman Brothers analyst Neil Herman wrote in a research note Wednesday that Microsoft likely has one more quarter of declining unearned revenue account balance ahead, but that the account should start growing again during the fourth quarter, which ends in June.

Shares of Microsoft closed Thursday down 29 cents at $28.01. The shares "continue to underperform most of the software industry and the broader market," Herman wrote; they're down 4% during the last three months, compared with a 10% increase in the value of the Nasdaq Composite Index during that time.

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