Strong Office 2007 Sales Push Microsoft to Record Profit

Published: May 2, 2007

by Alex Woodie

Strong sales of Windows Vista and Office 2007 in particular propelled Microsoft's profits for the quarter ended March 31, the software giant announced Thursday. The company was expecting to book its fair share of Vista revenue, but the pace of sales of Office 2007 caught the company by surprise, as it turned in a $4.93 billion profit for the quarter, a 65 percent increase from a year ago and a record for the third quarter.

Microsoft reported total revenue of $14.4 billion for the quarter, a 32 percent increase over the same period of the prior year. Operating income for the quarter was $6.59 billion, while earnings per share (EPS) grew 72 percent to $0.50 per share. "I am extremely pleased that we delivered a quarter of strong double-digit growth for revenue, operating income and EPS," said Chris Liddell, Microsoft's chief financial officer.

Driving the bulk of this revenue was the Client division, which is responsible for developing all versions of Windows. The Client division hauled in $5.27 billion for the quarter, two-thirds more than the same quarter of fiscal year 2006, and more than double what the division brought in on a quarter-to-quarter basis.

Revenues for the Microsoft Business Division, which sells software ranging from Dynamics ERP applications to the Office 2007, also surged on better-than-expected sales of the new version of Office. Revenue in this division increased 34 percent to $4.83 billion. Liddell said there was a "better than expected" response to Office 2007.

Microsoft was expecting a good quarter, largely the result of deferrals of sales from the second quarter to the third as part of Microsoft's "technology guarantee" program, but it wasn't expecting the numbers to be this good. The results exceeded the company's revenue expectations by $400 million to $700 million, and exceeded operating income expectations by $300 million to $500 million.

Much of the revenue increases in the Business and Client divisions resulted from the technology guarantee, which Microsoft instituted in late 2006 to prop up hardware sales after it failed to deliver Vista in time for the holiday buying season. Under the technology guarantee program, Microsoft offered customers coupons for Vista and Office 2007 to entice them to buy new PCs during the holiday season, which they could then load Vista and Office 2007 onto when they became available. When Vista and Office 2007 shipped to consumers on January 30, customers started submitting their coupons, allowing Microsoft to book the revenues and the profits.

With the technology guarantee removed from the equation, revenue goes down $1.7 billion to $13.7 billion, which translates into a 17 percent increase from the comparable quarter (compared to 34 percent with the guarantee). Microsoft's net income drops by $1.14 billion to $3.79 billion without the guarantee, which translates into a 27 percent increase (compared to a 65 percent increase with it).

As the numbers show, even with the deferred revenue from the technology guarantee program, it was a very good quarter for the world's largest software company, and makes one wonder what CEO Steve Ballmer was thinking when he downplayed Vista's sales expectations. "We're extremely pleased. Our results were primarily driven by Vista and the 2007 Office System, which are off to a very good start," Liddell said during the conference call following the earnings release. "We expect a strong finish to what has been an excellent year."

Microsoft's Server and Tools division, which had been responsible for much of the revenue increases in quarters past, delivered 15 percent year-over-year revenue growth to $2.75 billion. Windows Server 2003, SQL Server 2005, and Visual Studio 2005 drive the bulk of the revenue in this division.

A ray of hope emerged from Microsoft's Online Services Business division, the unit that competes for online ad revenue with Google and Yahoo, and which had been stuck under what seemed like a perpetual cloud. Revenue increased 11 percent for the quarter, to $620 million. Microsoft attributes the up tick to a 23 percent increase in advertising revenue, and better "monetization" of its new adCenter technology in the U.S. market.

The Entertainment and Devices division suffered a 21 percent year-to-year decrease in revenue, and a 69 percent quarter-to-quarter decrease, to $930 million. This decline is largely due to slower Xbox 360 game console sales (only 500,000 during the quarter, for a total installed base of 11 million), and hefty competition from the less-expensive Nintendo Wii console. Microsoft hopes Halo3 can prop up Xbox 360 sales when it ships.

Liddell is bullish on the fourth quarter, and expects Microsoft to bring in between $13.1 billion and $13.4 billion in revenue, which would amount to a growth rate of between 11 and 14 percent. Looking forward to Microsoft's fiscal 2008, which starts July 1, Liddell expects revenues of between $56.5 billion and $57.5 billion, or 11 to 12 percent growth.

The current IT spending environment is stable, Liddell says, and is being driven primarily by consumers. "'07 spending has been healthy. There is softness in server hardware growth, but it's not having a big impact," he said.

The wild card in Microsoft's financial future is what happens in the consumer segment, according to Liddell. Microsoft is not banking on a big increase in IT spending by businesses, which have given Vista a lukewarm reception.

At this point, Microsoft's plan is to continue enhancing its core money-makers--Windows, Office, and server and tools products--while driving "new opportunities in online and entertainment," Liddell said.

Over the next 12 months, we'll see a series of product releases by Microsoft, including Windows Server "Longhorn," Dynamics CRM and CRM Live, Office Communications Server, PerformancePoint Server, ForeFront Security products, a new release of Visual Studio, more Live Services, and of course the all-important Halo 3 game.

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