• Chart: Profit and Loss by Business Segment
• Chart: Deferred Revenue Changes

The Client and Information Worker business units made lower profits in the last quarter of fiscal year 2003 than in the first three quarters as a result of higher marketing costs and seasonal factors, according to a recent filing with the U.S. Securities and Exchange Commission. The filing also showed that MSN narrowed its losses significantly in the same quarter, which ended June 30, 2003.

Microsoft also indicated it will defer less revenue from OEM and retail sales of desktop software, and will recognize this deferred revenue over a longer period of time. This change reflects longer development cycles for new versions and fewer incremental updates to Office and Windows, and it will lead to a small (between 1% and 3%) increase in short-term revenue, particularly in the Client and Information Worker businesses, and a corresponding decrease in unearned revenue.

Finally, the company announced it would pay a US$0.16 per share dividend to shareholders in Nov. 2003.

Two Years' of Profit and Loss Data Now Available

Microsoft's 10-K for fiscal year 2003 was filed in Sept. 2003, completing the first year in which the company reported profit and loss for each of its seven business units. In addition, because Microsoft reported comparable FY'02 figures each quarter, it is now possible to see each business unit's profit and loss for the last eight quarters—the most complete financial picture of the company's business units yet. (For a chart showing profit and loss for the last five quarters, see "Profit and Loss by Business Segment".)

The filing reveals that in Q4'03, the Client and Information Worker business segments—the two businesses that account for the bulk of Microsoft's revenues and profits—had their lowest profits since Q4'02. The lower Client figures are due mainly to seasonal sales patterns for desktop PCs and the natural buying cycle as Windows XP becomes older (it was released in Oct. 2001). The Information Worker figures are due to similar seasonal factors, as well as advance marketing costs for Office 2003.

MSN only lost US$48 million in Q4'03, cutting its losses almost 50% from the previous quarter and 75% from the same quarter last year. Aggressive cost-cutting measures, such as the elimination of expensive promotions used to build subscriber numbers, and increased revenues from advertisement sales, particularly paid search listings, are credited for MSN's results.

The filing also revealed how price cuts on the Xbox console affected profits in the year-ago quarter, Q4'02. The Home and Entertainment business lost US$521 million in Q4'02 as Microsoft cut the price of the console in the U.S. from US$300 to US$200. (Microsoft loses money on each console and expects to make it up on sales of games and subscriptions to the Xbox Live online gaming service.) The segment did much better in Q4'03, losing only US$225 million, because costs of the console have come down and fewer units were sold.

Change to Deferred Revenue

For many years, Microsoft has set aside some revenues from OEM and retail sales of Windows clients and desktop applications such as Office, then recognized this revenue over the lifetime of these products. Microsoft does this to account for elements of these products that it delivers after the release date for no extra charge, such as service packs, updates to Internet Explorer (which is considered part of Windows), and free telephone support.

In its Q4'03 earnings call in July 2003, Microsoft revealed that it has reduced the minimum amount of revenue it defers for Windows clients and applications, and will recognize this deferred revenue over a longer period of time. (For details, see the chart "Deferred Revenue Changes".) According to Chief Financial Officer John Connors, the effect of these changes will be small: the Client business will gain approximately US$266 million in earned revenue in FY'04 (out of total expected revenue of more than US$11 billion) and Information Worker will gain US$133 million (out of total expected revenue of more than US$10 billion). These figures will be offset by an identical drop in unearned revenue.

Microsoft is deferring less revenue because it expects to release fewer updates over the lifetime of these products. In particular, it expects to spend less money developing individual components of Windows, such as Internet Explorer and Windows Media Player. Deferred revenue will be recognized over a longer period of time because the company expects a longer time to elapse between releases of these products. The follow-ons to Windows XP and Office 2003, for instance, aren't expected until FY'06 (which starts July 1, 2005).

Microsoft's unearned revenue amounted to US$9.02 billion on June 30, 2003. Most of this unearned revenue—US$5.47 billion—came from multiyear licensing agreements, which are not affected by this change.

Dividend Doubled

Microsoft's board of directors has approved an FY'04 dividend of US$0.16 per share, up from US$0.08 per share in FY'03. All shareholders of record as of Oct. 17, 2003 will receive the dividend payout on Nov. 7, 2003. Subsequent annual dividend payouts are expected to be issued in November, rather than March. (Microsoft's first dividend was issued in Mar. 2003.)

The increased dividend is intended to increase the appeal of Microsoft stock and address investors' concerns that the company is holding on to more cash than it needs for legal payouts and unexpected business downturns. The dividend will return about US$1.73 billion to investors from Microsoft's approximately US$49 billion in cash and short-term investments.

Resources

For more financial data, including a link to the FY'04 10-K filing and the 2003 annual report, see www.microsoft.com/msft.

Additional financial results for Q4’03 can be found in "Q4’03 Shows Companywide Growth" on page 32 of the Aug. 2003 Update.