Microsoft revenue up 12% in quarter

A Microsoft Corp. division that competes head-to-head with the open-source Linux operating system posted sharply improved financial results, helping to fuel a strong quarter for the Redmond software company.

Operating profit for Microsoft's Server and Tools division rose 84 percent, to $701 million, in the quarter ended Sept. 30. The company credited the improvement to a boost in shipments of Windows-based computer servers and a minimal increase in expenses within the division.

Companywide, Microsoft yesterday reported quarterly revenue of $9.19 billion, up 12 percent from the same quarter last year. Quarterly earnings per share were 27 cents, beating the company's own expectations by 2 cents.

Not including expenses related to stock-based employee compensation, the earnings per share figure would have been 32 cents. That was 2 cents per share higher than the expectations of analysts polled by Thomson Financial.

Despite the strong results for the quarter, some analysts and investors were concerned by a larger-than-expected decrease in the company's balance of unearned revenue -- billings from long-term software deals counted as revenue over time. Microsoft had previously predicted a decrease of $200 million to $300 million in the balance.

In fact, it fell by close to $400 million, to $7.8 billion. Microsoft attributed the difference, in part, to business customers taking longer than expected to renew software contracts.

"I want to caution you not to read this as an indicator of weakness in our business during the quarter," John Connors, Microsoft's chief financial officer, said during a conference call with analysts. "I do believe that investors have become overly focused on unearned revenue and have missed the bigger picture."

Microsoft kept its projection for year-end unearned revenue steady. But shares of Microsoft fell to $28.10 in after-hours trading, after finishing regular trading at $28.56.

The attention to unearned revenue is understandable because of its role as an indication of future business, said Alan Davis, an analyst at McAdams Wright Ragen in Seattle. At the same time, Davis called Microsoft's explanation reasonable and said he is "not overly concerned" with the unearned revenue decrease.

Microsoft also boosted its outlook for the current fiscal year, saying it now expects annual revenue to be between $38.9 billion to $39.2 billion, slightly more than it had projected previously. Microsoft said revenue in the current quarter, to end Dec. 31, should range from $10.3 billion to $10.5 billion. That's slightly lower than the average expectation of $10.6 billion among analysts surveyed by Thomson Financial.

Separately, analysts saw the Server and Tools result as positive news for Microsoft in its struggle against Linux, which has made deep inroads against Windows in the market for computer servers. Although Linux is available free over the Internet, Microsoft is trying to convince corporate and government customers that the total cost of installing, running and maintaining the software is more than with Windows.

Microsoft's server division was the company's "shining star" for the quarter, said Sanford C. Bernstein & Co. analyst Charles Di Bona. Revenue in the division topped $2.2 billion, a 19 percent increase over the same quarter last year.

"Linux is there. It's an issue for Microsoft, but it's not what it's built up to be in the press, and in the analyst community, frankly," Di Bona said. "It's a legitimate threat, but not a Microsoft killer -- at least not yet."

The relatively slight increase in the server division's operating expenses, about 2 percent, reflects an overall effort by Microsoft to tighten its corporate belt through a variety of cost-saving initiatives. Microsoft's Connors reiterated yesterday that the company expects to see revenues grow faster than expenses across the company.

Connors said he continues to expect the Microsoft Business Solutions and Mobile & Embedded Devices divisions to reach profitability in 2006. Each saw its revenue increase and its operating loss decrease during the recent quarter.

Microsoft's Home and Entertainment Division, which includes the Xbox video-game console, expects to hit profitability in 2007. It also reported improved results yesterday, with revenue of $632 million for the quarter, a 9 percent increase, and an operating loss of $142 million, compared with an operating loss of $273 million in the same quarter last year.

The company's MSN Internet division remained profitable, posting operating profit of $77 million, aided by a $56 million increase in advertising revenue.

That phenomenon wasn't limited to the Microsoft division. Google Inc., one of MSN's primary competitors in the search business, also cited strong advertising sales yesterday as it reported its first quarterly results as a public company.

Microsoft's flagship products, Windows and Office, also did well in the quarter. The Client division, which includes versions of Windows for personal computers, posted revenue of nearly $3 billion for the quarter, a 7 percent increase, with operating income of nearly $2.4 billion, up 6 percent.

The Information Worker division, which includes Office and related products, reported quarterly revenue of more than $2.5 billion, up 14 percent, and operating income of $1.9 billion, an increase of 18 percent.

One area where Microsoft slipped was investment income, which fell to $279 million for the quarter, compared with $753 million in the same quarter last year.

The company attributed the drop, in part, to a shift toward more liquid, lower-yielding investments in preparation for a coming payout of up to $75 billion, including a special dividend of $3 per share, or $32 billion.

Assuming shareholder approval at the company's annual meeting next month, the dividend is scheduled to be made Dec. 2 to shareholders of record as of Nov. 17.

That payout and a planned stock buyback of as much as $30 billion are expected to decrease the company's cash reserves significantly in the long run. At the same time, the company continues to generate huge sums of cash each quarter. The balance of cash and short-term investments reached nearly $64.5 billion in the recent quarter, an increase of $4 billion from three months ago.

P-I reporter Todd Bishop can be reached at 206-448-8221 or toddbishop@seattlepi.com

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