NEW YORK (CNN/Money) -
For those brave souls who dare delve into the murky legalspeak of Microsoft's S.E.C. filings, there was a pleasant surprise in the software giant's first quarter filings this week: clarity.
In the past, combing through a Microsoft quarterly report in search of a comprehensible revenue breakdown was as confounding as it was useless. But in an effort to achieve more transparency in its earnings information, Microsoft has overhauled its reporting structure, and the results are enlightening.
For example, the company enjoyed a jaw-dropping 85 percent profit margin on $2.9 billion in revenues in its "Client" division, which includes all of the Windows operating System products. We all knew Windows was a cash cow, but 85 percent? That's a lot of moo-lah.
In its other divisions, Microsoft's numbers are less impressive, though hardly negligible. The "Server Platforms" division, which includes the company's so-called back-office products, like SQL Server, earned 34 percent on sales of $1.5 billion, and the "Information Worker" division, which harbors Microsoft's Office line of applications, earned 78 percent on sales of $2.4 billion. No slouch in its own right.
As for the rest of Microsoft's newly designated divisions, the numbers are all red. "Business Solutions," "CE/Mobility," "MSN," and "Home and Entertainment" all lost money in the quarter. Particularly ugly was the "CE/Mobility" unit, which lost almost twice as much ($33 million) as its sales ($17 million.)
Microsoft's old breakdown format was corporate ambiguity at its best, and caused more than its share of frustration for investors. But the new more comprehensive reporting method, created this summer to better reflect the company's internal structure, has its own drawbacks.
At first blush, investors may be tempted to question Microsoft's attempts at diversification, due to the fact that the company's forays into handhelds, gaming, and Internet access are all costing them gobs of money. But such a view would be shortsighted.
Each part of this company, including the loss-making divisions, is part of a well-conceived, comprehensive strategy, a classic whole-is-greater-than-the-sum-of-its-parts strategy, otherwise known as .Net. Besides, all of Microsoft's products have lost money at some point. It's the nature of the software business: heavy upfront research and development costs, followed by years of high margin sales.
The loss-making divisions are still in their early stages, and investors will need to remain patient while the company funds them with their sizeable profits from the more established businesses.
"It is very important not to look at these things as independent investments," warns Charles Dibona, analyst at Sanford Bernstein. "Some of these are businesses they are still bringing along, like a venture capital portfolio."
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As for the astounding earnings prowess of the Windows franchise, we really shouldn't be all that surprised. While the numbers will surely rile lawmakers who had hoped for greater constraints on Microsoft following the Department of Justice settlement, margins in the 80 percent range are not entirely uncommon in the software business. Oracle's overall gross margins are consistently around 80 percent, PeopleSoft hovers near 70 percent.
So take heart consumers, Microsoft isn't sticking it to you as much as you might think. As Microsoft spokesperson Caroline Boren says, "Windows is intellectual property that resulted from billions of dollars of research and development."
In general, clarity and transparency are good things in earnings statements. And Microsoft is no different in this regard. But as investors, we are obligated to understand earnings breakdowns in the larger context of the corporate strategy.
You may agree or disagree with the company's overall direction, but Microsoft has certainly proven that it can grow new business with healthy margins from scratch. So be patient, and some day Microsoft will be sporting a whole herd of cash cows.
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