• Chart: Microsoft Financials for the Last Five Quarters
• Chart: Revenues by Product Line

Recognition of unearned revenue booked in previous quarters and slow sales of Xbox consoles (on which Microsoft loses money) helped Microsoft post its highest-ever profit—US$2.79 billion—in the third quarter of fiscal year 2003, which ended on Mar. 31, 2003. Quarterly revenues were also strong at US$7.83 billion, although they fell short of the previous quarter's record of US$8.54 billion.

(For an overview of Q3’03 financial results and how they compare with previous quarters, see the chart "Microsoft Financials for the Last Five Quarters".)

Server Shines, Xbox Declines

Of the company's seven business segments, Server Platforms showed the strongest results, with revenue growing 21% over the same quarter a year ago. This growth was primarily driven by recognition of unearned revenue booked in previous quarters, stemming from companies rushing to take advantage of new licensing rules that took effect on July 31, 2002. In addition, according to Chief Financial Officer John Connors, the Server Platforms business benefited from growth in Windows Advanced Server and SQL Server Enterprise Edition as companies upgraded from the less-expensive Standard versions of these products.

Microsoft's other core businesses showed solid growth as well. Revenue in the crucial Windows Client business was up 9% from the previous year, and for the first time, more than half (56%) of all Windows Client systems sold during the quarter were the higher-priced Professional Edition of Windows XP. However, Connors suggested that this growth in the "mix-shift" toward Windows XP Pro, which has been driving growth in the Client business for the last several quarters, would slow greatly in FY'04; he noted that businesses accounted for most of this mix-shift, and they buy about 60% of the copies of Windows sold, with consumers purchasing the rest.

Microsoft also saw 10% revenue growth in the Information Worker business, driven largely by recognition of unearned revenue from previous quarters, and by 40% growth from products other than the Office suite—particularly Project, which Microsoft said could account for US$500 million in revenue in FY'03. The result bodes well for the unit's efforts to earn more money from products outside the core Office suite and from integrated solutions, such as the company's professional services accounting solution, that draw on those products. (See "Information Worker Focus of New Client Plans" on page 26 of the Oct. 2002 Update.)

The Home and Entertainment business fared poorly compared with the previous year, showing a 42% drop in revenue. Much of this drop was due to a bad year-to-year comparison for Xbox, as the console launched in Europe and Japan in the same quarter a year ago. However, sales across the entire segment were weak, with revenues from consumer software (such as Encarta and Macintosh software) and hardware (such as keyboards and mice) dropping 22% over the previous year.

The company's other consumer business, MSN, posted 26% revenue growth from a year ago, mainly thanks to a 55% increase in advertising and paid search revenues. Despite a sequential decline in MSN subscriber numbers to 8.7 million, revenue from subscribers went up 9% as non-paying customers left the service after their initial incentive programs expired. Connors said he expected these subscriber number declines to continue, leading to lower revenue but lower losses (or, for the first time, profits) for MSN in subsequent quarters.

(For a complete chart of revenue by category and a comparison with one year ago, see "Revenues by Product Line".)

Unearned Results, Sales Investments

As expected, Microsoft's total unearned revenue fell in Q3'02 for the second consecutive quarter, reflecting the fact that fewer companies are signing new multiyear licensing agreements than did so under incentive programs that ended July 31, 2002. Connors predicted that this trend would end next quarter with sequential unearned revenue growth of between US$100 million and US$200 million, as companies pay for the second year of multiyear agreements signed before the July 2002 deadline. Unearned revenue is a key component of Microsoft's overall finances—26% of its total revenue in Q3'03 came from recognition of previously unearned revenue.

Connors also noted several critical areas of spending in the next few quarters, including increasing the value of Microsoft's Software Assurance upgrade plan, creating demand among small and mid-size businesses and building the partner channel in that space, a renewed focus on the academic and public sectors, and developer evangelism.

During the earnings call, Microsoft announced that Vice President Scott Boggs is leaving the corporate controller job to take an unannounced position elsewhere at the company. He is being replaced by Scott DiValerio, formerly of Disney and Pricewaterhousecoopers.

Resources

Microsoft will break out Q3'03 profit or loss for its seven business categories in its 10-Q filing with the U.S. Securities and Exchange Commission, which will probably be filed in mid-May.

Detailed information about Microsoft's Q3'03 results and financial history is available at www.microsoft.com/msft.