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Microsoft lowers earnings estimates

The software giant joins the growing list of companies in the tech sector issuing profit warnings.

John Connors Software giant Microsoft on Thursday joined the growing list of tech companies issuing profit warnings.

After market close, the Redmond, Wash.-based company announced that earnings for its 2001 fiscal second quarter would be 5 percent to 6 percent lower than expected--in the $6.4 billion to $6.5 billion range. The company said earnings per share would fall in the range of 46 cents to 47 cents for the quarter, which ends Dec. 31.

A consensus of analysts expected 49 cents per share, according to First Call/Thomson Financial.

Microsoft also revised its full-year fiscal 2001 expectations, projecting about 5 percent less than anticipated. For the year, Microsoft estimates revenues between $25.2 billion and $25.4 billion and earnings per share in the $1.80 to $1.82 range.

The last time Microsoft warned of lower-than-expected earnings George Bush the elder was in the White House. In 1989, the company announced that revenue for the January-to-March quarter wouldn't meet expectations. But then, Microsoft went on to meet the earlier forecast.

The company's current problems come largely from two factors. A slowdown in the PC market has lead to a corresponding decline in sales of the various versions of the Windows operating system.

The bigger problem, however, is that sales of software applications such as Microsoft Office are off. Typically, large companies buy new versions of Office when they upgrade their computers or adopt a new version of Windows. Not only are PC sales slow, but corporations have adopted Windows 2000 at a slower rate than analysts had expected, leading to a ripple effect.

In after-hours trading, Microsoft shares were at $51.88, a 6.5 percent drop from the closing price of $55.50. The stock is trading at less than half of its 52-week high of $119.93.

Signs of trouble had been brewing for a week, starting when Goldman Sachs analyst Rick K. Sherlund lowered estimates for Microsoft one week ago. Prudential Securities analyst Douglas J. Crook followed on Wednesday.

"People were afraid of a profit warning and had been lowering their guidance accordingly," said analyst Laura Lederman at William Blair. "But apparently they didn't go low enough."

John Connors, Microsoft's chief financial officer, blamed the company's problems on the economic downturn.

"We are seeing slowing global economic conditions, particularly the U.S.," Connors said in a conference call with financial analysts. "We are seeing some softness in general spending in IT accounts, which has impacted our desktop software sales."

Connors also noted Microsoft is "seeing an industrywide slowdown in online advertising sales and subscription and revenue growth, which has affected our consumer segment." That change unexpectedly hurt MSN revenues, he said. But most of the sales slowness is in desktop software.

Microsoft's CFO said the company started out the year more cautious than many other companies about the growth of the PC market.

"In retrospect, we may have been earlier than many others in the tech sector in making that cautious call, but we did not anticipate the deceleration in the world economy we are now seeing," Connors said.

Microsoft had anticipated PC growth in the mid-teens, but in reality the rate will be "a couple points lower," Connors said.

Gartner analyst Chris LeTocq agreed that Microsoft is taking a hit in two major areas: sales of software to PC manufacturers and a slower-than-expected growth rate in software applications.

"There is a direct reflection of the economic slowdown on PC manufacturers," he said. LeTocq noted that 46 percent of Microsoft's revenue comes from software applications, "and they're not doing anywhere as well as Microsoft expected."

Windows 2000: The next generation LeTocq also noted that Windows 2000 adoption fell far short of the mark set by analysts.

"Windows 2000 hasn't accelerated at quite the rate that Microsoft wanted. It's picking up some speed right now, but certainly organizations we've seen have been very cautious," he said.

In fact, less than 10 percent of desktops with Windows 95, 98 and NT have converted to Windows 2000, according to Gartner. In February, Gartner predicted that 15 percent to 20 percent would be converted by now.

But during the conference call, Connors said that desktop and server Windows 2000 sales were in line with Microsoft's projections. And the company has continued to win new customers during the current quarter.

The technology sector has been hit hard recently by earnings warnings.In the past two weeks, Apple Computer, Compaq Computer, Gateway, Intel, Motorola and 3Com have all warned of earning shortfalls for their current quarters.

Connors said it took Microsoft longer than some other technology companies to see the effects of economic conditions and slowing consumer PC sales on the quarter's revenue.

Chipmakers tend to see the effects first, followed by the PC makers. "Lastly, Microsoft gets reports in from (manufacturers) several weeks later, telling us about the volume of Windows operating systems installed on those PCs," Connors said.

He remained optimistic beyond fiscal 2001, emphasizing Microsoft's broadening product line and the scheduled releases of both Office 10 and the next-generation consumer operating system, Whistler.

While sales growth is strong in Asia, Europe has not picked up as anticipated, and the United States slowed unexpectedly, Microsoft's CFO said.

"The enterprise space appears to be impacted less than the consumer PC sector" or the consumer online sector, Connors said.

During the conference call, financial analysts repeatedly pressed Connors on the sales slowdown in desktop applications. Several analysts seemed confused how sluggish PC sales could affect sales of applications more than of Windows OS.

One way that Microsoft sells desktop applications is through license programs to corporations, Connors said. "We anticipate our results from those licensed businesses for our desktop applications will be lower in the December quarter and the second half" of fiscal 2001.

He did not explain this change other than to say sales were not as high as Microsoft anticipated.

But the impact of the slumping consumer market is clear: Some PC makers offer Office on new personal computers, and consumers also buy Office and other desktop applications separately.

LeTocq emphasized that the slowdown in desktop applications is the crux of Microsoft's problems and that the company has failed to respond to the way companies buy software.

"For a lot of organizations, they look at the applications they have on their desktops now and see that things work," LeTocq said. "Our guidance to organizations for some time is you don't need to upgrade with every version. Every other version is just fine."

Microsoft typically works on an 18-month to two-year cycle for new versions of Office, but Gartner has found companies are more inclined to wait three years or more.

"Increasingly what organizations are doing is they don't get new applications until they get some new hardware in," LeTocq said.

Short term, this creates a big problem for Microsoft because so much revenue comes from desktop software. "Until they get their .Net strategy in place and subscription revenues coming from that, Microsoft could be in trouble," LeTocq said.

Staff writer Larry Barrett contributed to this report.