Microsoft meets lowered expectations

The Redmond, Wash.-based software maker posted earnings of $2.62 billion, or 47 cents a share. A consensus of analysts polled by First Call had projected quarterly earnings of 47 cents per share. A year earlier, Microsoft's net income topped $2.44 billion, or 44 cents a share.

Revenue rose 8 percent year-over-year to $6.59 billion. A year earlier, Microsoft reported record sales of $6.11 billion.

In December, Microsoft joined a chorus of other high-tech companies issuing quarterly profit warnings. At the time, the company said revenue would be between 5 percent to 6 percent lower than expected, or in the $6.4 billion to $6.5 billion range. Microsoft had also lowered expectations for its fiscal year 2001, ending June 30, to between $25.2 billion and $25.4 billion, with earnings per share in the $1.80 to $1.82 range. The analyst consensus currently is $1.81 for fiscal 2001, according to First Call.

Microsoft offered additional guidance Thursday, projecting fiscal third-quarter revenue between $6.3 billion and $6.4 million and diluted earnings of 42 cents or 43 cents a share. The company reiterated its earlier fiscal 2001 guidance.

Microsoft faced several challenges in the quarter, some of which are expected to spill over into the remainder of the fiscal year. Consumer computer sales plummeted during the holidays--down 30 percent at retail, according to PC Data--and slowing corporate spending affected the commercial market.

"While we are enthusiastic about the breakthrough products and services the company will be delivering in 2001, we remain guarded about the near-term economic outlook and its impact on PC demand and technology spending," John Connors, Microsoft's chief financial officer, said in a statement.

"We think worldwide PC growth for all of our fiscal year 2001 will be in the low double digits, the very low end of double digits," Connors told financial analysts during a conference call following the announcement.

"We continue to expect consumer PC growth will continue to outpace business PC growth, which has been the trend for the last several quarters."

The company already faced challenges, as Windows 2000 sales had not picked up to levels analysts had forecast at the product's launch. Less than 10 percent of Windows 95, 98 and NT desktops were converted to Windows 2000 last year, according to market researcher Gartner.

But the quarter showed signs of a rise in Windows 2000, despite the PC market slowdown. Microsoft reported sales of desktop operating systems rose 13 percent year over year to $2.06 billion.

"Windows 2000 has gained momentum, and we're expecting that (to continue) in the last half" of the fiscal year, Connors said.

Server operating sales rose 21 percent to $1.24 billion compared to a year earlier. The company also reported a 26 percent increase in Exchange Server and SQL Server client licenses from a year earlier.

But Microsoft's bread-and-butter product line, desktop applications, took a hit, with revenue declining 2 percent year over year, to $2.49 billion from $2.53 billion.

"When you look at Microsoft's revenue picture and ask where is their sensitivity, the sensitivity is Office, which is 46 percent of their revenue and over 50 percent of their earnings," said Gartner analyst Chris LeTocq. "When slowdowns happen in the largest part of what you sell, that's when you get some reflection in your bottom line."

The software giant reported troubles from its MSN Internet service. While revenue for the consumer software, services and devices segment rose 9 percent year-over-year to $506 million, rebate programs sapped MSN revenue--that despite MSN network services revenue doubling year-over-year. Microsoft reported gaining 500,000 new MSN subscribers during the quarter.

Retailers relied heavily on $400 MSN rebates to sell PCs during the holidays. Customers agreeing to make a three-year MSN commitment with their PC purchase received an instant $400 rebate subsidized by Microsoft.

But Microsoft also extended the rebate to other non-PC products. Retailing giant Best Buy, for example, sold 200,000 MSN subscriptions worth about $80 million in instant rebates on anything in the store.

"Obviously stores used the rebates to drive sales across other categories," said PC Data analyst Stephen Baker. "It means maybe people aren't as tied to the Internet as a PC thing, so people used that $400 to get a big-screen TV."

While the software giant took an initial revenue hit from the rebates, it is expected eventually to recoup the money through subscription fees and additional services.

Consumer online revenue from Expedia, Home Advisor and CarPoint jumped to $99 million from $30 million a year earlier. Revenue from other products, such as hardware and Microsoft Press, declined to $188 million, from $230 million.

Original equipment manufacturer (OEM)revenue rose 9 percent to $2.05 billion from $1.87 billion a year earlier.

Geographically, South Pacific and the Americas accounted for $2.37 billion, a 7 percent increase from a year ago. Revenue for the Europe, Middle East and Africa region was flat year over year at $1.43 billion. Asia saw revenue increase 22 percent from a year earlier, to $737 million.

Looking ahead, Connors gave in-depth guidance for the third quarter.

He projected desktop software revenue growth "in the high single digits on a year-over-year basis, and we're looking for about the same growth in the June quarter."

But Connors cautioned desktop applications would "grow just slightly," while desktop operating systems would "grow in the mid teens" year-over-year.

Server operating system sales are projected to grow in the high teens for both the third and fourth fiscal 2001 quarters. But Connors cautioned "the strong results on the servers and services front will be impacted by year-over-year declines in our developer tools revenues, as customers await Visual Studio.Net in fiscal year 2002."

Microsoft projects consumer software, services and devices segment sales to increase in excess of 20 percent for the next two quarters.

"Our consumer services group should grow in the high 20-percent range each quarter, while games and devices grow in the high teens," Connors emphasized.