Microsoft earnings slip below targets

Revenue rises in the third quarter, but software maker doesn't do as well as some analysts expected.

Ina Fried Former Staff writer, CNET News
During her years at CNET News, Ina Fried changed beats several times, changed genders once, and covered both of the Pirates of Silicon Valley.
Ina Fried
4 min read
Microsoft on Thursday reported third-quarter sales and earnings that were below what some analysts were expecting and said future earnings will be dented as it aims to boost its Windows Live Internet services and other new businesses.

For the three months ended March 31, the software maker said it earned $2.98 billion, or 29 cents per share, on revenue of $10.9 billion. That compares with earnings of $2.56 billion, or 23 cents per share, on sales of $9.62 billion for the same period a year ago.

The third-quarter earnings were dented by legal costs that amounted to 3 cents per share, while the year-ago numbers were impacted by 5 cents per share related to legal costs.

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Analysts were expecting the company to earn 33 cents per share on revenue of $11.04 billion, according to First Call. Microsoft said in January to expect $10.9 billion to $11.2 billion, with per-share earnings of 32 cents or 33 cents.

Colleen Healy, a general manager in Microsoft's investor relations unit, told CNET News.com that the weaker earnings came as Microsoft invested money in its services push and also as it tried to ramp up production of the Xbox 360 games console.

The company also offered a sales forecast for the current quarter and next fiscal year that was largely in line with what analysts were expecting. But it did say that earnings would come in lower, as it invests in its services push, as well as in the launch of Windows Vista and Office 2007.

Microsoft's three main business units, which sell desktop and server versions of Windows, all saw both profits and sales grow during the quarter.

However, Microsoft saw its MSN unit dip into the red, as revenue dropped from a year earlier. The Home and Entertainment unit, whose chief product is the Xbox, saw its revenue grow to $1.06 billion, from $571 million a year ago, as the company boosted shipments of the Xbox 360. However, as the initial units ship at a loss, Microsoft saw its operating loss in the unit grow to $388 million, from $175 million in the year-ago quarter.

The Microsoft Business Solutions unit, which has been losing money but produced an operating profit in the December quarter, dipped back into the red in the last quarter. It lost $13 million, though its revenue grew to $216 million, from $179 million in the year-ago quarter.

The mobile and embedded devices unit, which includes the Windows Mobile software for handhelds and cell phones, saw its operating loss widen to $14 million from $9 million a year ago, as sales climbed to $89 million from $61 million a year ago.

For the current fourth quarter, Microsoft said to expect revenue of between $11.5 billion and $11.7 billion, with operating income between $4 billion and $4.2 billion and per-share earnings of around 30 cents. Analysts had been predicting earnings of 34 cents per share, on revenue of $11.64 billion.

Healy said that Microsoft wants to continue investing in adding people to its services unit, as well as spending on physical hardware and continued improvement of its search algorithms. "We see that we have an opportunity out there and we are going to agressively go after it," she said.

The Redmond, Wash.-based software maker also gave its preliminary guidance for the new fiscal year, which starts in July. Microsoft said to expect revenue of $49.5 billion to $50.5 billion and per-share earnings in the range of $1.36 to $1.41.

In addition to continued investment in services, Healy said that Microsoft plans to spend money to market the launch of Windows Vista and Office 2007. Both products were originally slated to launch late this year, but are now set for a mainstream release in January.

Bernstein Research analyst Charles Di Bona said in a research note this week that he expects revenue for the coming year to be $50.48 billion and per-share earnings for the fiscal year of $1.54.

Microsoft's stock dropped in after-hours trading after the report. Shares changed hands recently at $25.66, down more than 5 percent after ending the regular session at $27.25.

On a conference call with analysts, Microsoft said its search revenue was lower than expected as the company continues to shift from Yahoo's ad-serving technology to its own AdCenter product. The company saw more searches done on MSN, but its revenue per search failed to match the amounts the company saw in the prior year. For the coming quarter, Microsoft predicted sales will fall between 4 percent and 5 percent as it continues its move to AdCenter.

As for its game unit, Microsoft said it shipped 1.7 million Xbox 360s in the quarter, with a disproportionate amount of the shipments coming in March. The company also said it now expects to ship between 5 million and 5.5 million of the new game consoles by the end of June, up from a prior forecast of 4.5 million to 5.5 million.

"In Q3, we addressed console supply challenges," said CFO Chris Liddell said on the conference call. However, he said that choice had resulted in increased cost to the company. The company also saw lower software-license revenue for the original Xbox as sales of games for the older console slowed more than expected.

Liddell said Microsoft understood that its decisions to invest in things like services and high-end computing will mean lower earnings in the short-term.

"We are willing to make those trade-offs."