Microsoft Sets Records for 2nd Quarter Revenues, Profit

by Alex Woodie

The cash-generation machine that is Microsoft set new company records for the $10.8 billion in revenue and $3.5 billion in net income it brought in during the second quarter of its 2005 fiscal year, which ended December 31, 2004. The records were driven by stronger spending in Microsoft consumer segments over the holiday season, as well as an 18 percent boost in server-related sales.

Microsoft's $10.8 billion in revenue for the quarter represented a 7 percent increase over its second quarter results for fiscal year 2004, which was the previous high-water mark for Microsoft's quarterly revenue, with $10.1 billion. The company also set a record with about $3.5 billion in net income, or profit, easily exceeding the $2.7 billion it brought in during its fourth quarter of fiscal 2004. (While the second quarter of fiscal 2004 brought in a lot of cash, it was the quarter in which Microsoft had to make a $2.2 billion payment to its employees' stock option program, which significantly ate into its profits.)

Server and Tools was Microsoft's fastest growing business segment, increasing from $1.98 billion during the second quarter of 2004 to $2.31 billion last quarter, an increase of $328 million, or 18 percent. Solid increases in sales of the three core products in this division (Windows Server 2003, SQL Server, and Exchange Server), as well as Client Access Licenses for these products, were the main drivers behind the growth.

Microsoft estimates that Windows-based server shipments grew 19 percent during the second quarter of fiscal 2005 compared with the prior year, and that this growth rate was 2 to 4 percent higher than growth in the overall server hardware market; Microsoft figures the overall server market grew 15 percent during the first and second quarters of its fiscal 2005 compared with the previous year. Favorable foreign exchange rates made the division's total revenue increase by $149 million.

While Microsoft expects Windows server sales to continue to track better than the overall server market for the rest of its year, there are several factors that will hurt Microsoft, the company says. These include continued strong competition from Linux and Unix; loss of revenue from the Upgrade Advantage program (which hurt the company to the tune of $85 million last quarter); and the addition of new workers to assist in the rollouts of SQL Server 2005 and Visual Studio 2005, the two biggest product announcements expected from this division this year.

Microsoft's Client division, which sells the Windows operating system, continues to bring in scads of revenue and profit for the company. Client racked up almost $3.2 billion for the quarter, an increase of $138 million, or 4.5 percent, from last year. The Information Worker division, which sells the Office suite, is still the second biggest division at Microsoft, with about $2.85 billion in sales last quarter, which actually was a decline of $2 million, or less than a tenth of a percent, from the same quarter last year.

The previously moribund Home and Entertainment division notched its very first profitable quarter (in terms of operating income), with about $1.42 billion in sales, an increase of 17 percent over last year. Still not out of the red are Microsoft's Business Solutions segment, which increased its quarterly loss to $23 million despite about a 5 percent increase in revenue to $206 million, and the Mobile and Embedded Division, which almost broke even on the back of a 47 percent increase in revenue to $85 million for the quarter; if trends hold, it should become profitable during the current quarter.

The MSN division posted a modest 3.5 percent increase in revenue to $617 million, which corresponded with a 29 percent increase in operating income. This makes MSN the fourth most profitable division at Microsoft (or third least, depending on how you look at it), behind Server and Tools ($783 million operating profit), Information Worker ($2.2 billion operating profit), and Client ($2.5 operating profit).

John Connors, outgoing CFO at Microsoft, says Microsoft's record revenue came from "across-the-board strength in both our business and consumer segments." In addition, he said the company's "long-term approach to growing new businesses is paying off," and pointed to the Home and Entertainment division's first profitable quarter in its history, and the $700 million improvement in operating results from the company's three emerging businesses.

All in all, the $3.5 billion in profit equates to $0.32 in diluted earnings per share. That's $.08 percent better than Microsoft's bean counters were expecting, and four times the amount of Microsoft's $0.08 quarterly dividend. This means that Microsoft's cash horde--which was knocked down from $92 billion on December 31, 2003, to $64 billion on December 31, 2004, largely due to the one-time $3-per-share dividend and the doubling of quarterly dividends that were issued last year--is once again growing at an astonishing rate.

Microsoft is expecting diluted earnings per share of about $0.27 for the current quarter, ending March 31, and a whopping $1.10 for the next quarter, which is traditionally its second strongest quarter. With all that cash accumulating in Microsoft's bank accounts, the company will soon need to decide what to do with it.