Sales up, profit off for Microsoft

The Redmond, Wash.-based software giant announced earnings of $2.74 billion, or 49 cents a share, including a 15-cents-per-share gain from the sale of Expedia to USA Networks and a 14-cents-per-share charge related to investment impairment. That compares with earnings of $2.45 billion, or 44 cents a share, for the same period a year ago, and 41 cents a share for the previous quarter ended Dec. 31, 2001.

Analysts polled by First Call had expected a profit of 51 cents a share, but a First Call representative said it was unclear the extent to which those estimates included investment write-offs. If estimates fully included investment write-offs, Microsoft fell a few cents short of the mark. If not, the company may have beat targets by a wide margin.

Estimates were on the high side of guidance given by Microsoft in January.

Microsoft shares were downly sharply--to $53.13 from the closing price of $56.37--in early after-hours trading Thursday on the Island ECN.

Revenue for the third quarter, which ended March 31, topped $7.25 billion, a 13 percent increase from the $6.4 billion reported for same period a year earlier. In January, Microsoft had projected sales between $7.3 billion and $7.4 billion for the quarter.

The company reported revenue of $6.46 billion in the year-ago quarter and $7.74 billion for the second quarter. Many analysts had tightened their revenue projections to just over $7.3 billion, based on concerns that Xbox and Office XP were not selling as well as expected.

Microsoft Chief Financial Officer John Connors emphasized cost-cutting gains in a statement accompanying the earnings release.

"We took another big bite out of costs this quarter, with single-digit operating expense (percentage) growth driving costs down and efficiency up throughout the entire organization," he said.

From now to year's end
Connors also reduced Microsoft's outlook for the current quarter and the full 2002 fiscal year, which end June 30. The company now expects revenue of $7 billion to $7.1 billion for the final quarter of the year. For the full year, revenue is forecast at $28.1 billion to $28.2 billion and earnings at $1.54 to $1.55 per share. In March, Connors said that Microsoft expected to report revenue of $28.8 billion to $29.1 billion for fiscal 2002 and earnings per share of $1.57 to $1.60.

For the current quarter, First Call estimates revenue of $7.65 billion and per-share earnings of 41 cents to 42 cents. For the full year, analysts had predicted per-share earnings of $1.87.

In a conference call with financial analysts, Chief Financial Officer John Connors attributed much of the third-quarter shortfall to lower-than-expected sales for the Xbox game console. He said the company now expects to sell 3.5 million to 4 million Xbox units for the year, compared with previous estimates of 4.5 million to 6 million.

"This revised forecast reflects the ongoing weakness in Japan and reflects the many weeks of sales opportunities lost in Europe while we were at the higher price," Connors said, alluding to the European Xbox price cut Microsoft announced early Thursday.

Microsoft also offered guidance for fiscal 2003, projecting revenue of between $31.5 billion and $32.4 billion, with projected earnings of $1.89 to $1.92 per share. Connors told analyst that while many of them expected better profit growth, Microsoft was investing in the future, spending more to develop Tablet PCs, security and storage products and boosting sales staff, particularly for server products.

"We need to have the sales force that can sell the products we've built," he said. "We're entering period where we will make some deep commitments to businesses we believe in for the long term."

Xbox off its game?
Financial analysts had been watching for the next year's fiscal guidance, particularly as an indicator of the health of the overall personal computer industry. In a research note published before the earnings announcement, Merrill Lynch analyst Chris Shilakes forecast fiscal 2003 revenue of $32.2 billion and earnings per share of $1.95.

"Solid results and commentary on CPU shipment rates from Intel did little to boost (Microsoft) stock on Wednesday," Shilakes said. "We expect (Microsoft) to maintain a conservative outlook with regards to PC ship rates, flat to down slightly year on year."

Mark Specker, an analyst at investment banking firm SoundView Technology Group, on Tuesday cut his estimates for Microsoft's fourth quarter and fiscal 2003, in part because of weak PC sales. For 2003, he reduced revenue estimates to $32.3 billion from $33.1 billion and earnings per share to $1.95 from $2.04.

"We have reduced our PC estimates by 1 million units for the September 2003 estimates and by 2 million units for the December 2003 estimates," he wrote. He also cut desktop applications estimates over concerns that Office XP, which Microsoft released in May 2001, was not doing as well as expected. Likewise, Specker reduced fiscal 2002 Xbox projections to 3.85 million units from 4.35 units.

Strength of Xbox sales had been a contentious issue coming into Microsoft's earnings announcement. On Monday, Chris Whitmore, an analyst at investment bank Deutsche Banc Alex Brown, estimated that Microsoft had sold only 300,000 units of the video game console in North America during the third fiscal quarter, compared with 1.5 million units during the last six weeks of 2001. He also projected minuscule sales in Japan of only 180,000 units--or 4,000 a week--since Xbox's February launch there.

Whitmore concluded that Microsoft would be hard-pressed to make its goal of selling 4.5 million to 6 million Xbox consoles before the end of fiscal 2002.

Poor sales in Europe may have led to an Xbox price cut announced there Thursday morning. Microsoft cut Xbox's price in Europe to $266 from $419, and in Britain to $288 from $434.

But in a Tuesday research note, Bernstein analyst Charles DiBona, who predicted shipment of 4.1 million Xbox units in fiscal 2002, said a shortfall might hurt revenue but should help earnings, as Microsoft subsidizes hardware costs for the game machine.

Product delays could also weigh heavily on fiscal 2003. During Microsoft's Windows Hardware Conference (WinHEC) in Seattle this week, the software giant revealed that Windows XP's successor, code-named Longhorn, would be delayed until at least the second half of 2004.

Another important product, .Net Server, is not expected to reach customers until early next year. Microsoft has already twice delayed the product, which is an important component of its .Net software-as-a-service strategy and of efforts by the company to move to steadier subscription revenue.

PC spending: Partially cloudy
Connors offered guarded optimism for the PC market, saying the company now see growth of a couple of percentage points for PC sales in the 2003 fiscal year, compared with a shrinking market during the current year. "We think it is still premature to describe the current trend as a full-blown recovery," he said.

Business spending was a cloudier issue, with business customers remaining reluctant to increase tech spending, said corporate controller Scott Boggs. "We still see enterprise customers being very cautious in their IT spending," he said.

Boggs added that quarter-to-quarter revenue numbers don't tell the whole story as Microsoft moves more business customers to multiyear licenses. Accounting procedures call for revenue for those sales to be recorded over the life of the contract, with sales for future years counted as unearned revenue. Unearned revenue totaled $6.91 billion as of March 31, compared with $5.31 billion a year ago.

"The trend toward annuity sales has been greater than we anticipated," Boggs said.