Brisk XP sales can't save Microsoft Q3

Microsoft Corp.'s fiscal third quarter revenue climbed 13 percent from a year ago, to US$7.25 billion, helped along by what it said were brisk sales of its recently launched Windows XP operating system. But the results fell short of what financial analysts had been expecting.

Net income for the period, ended March 31, was $2.74 billion, including an $847 million after-tax gain from the sale of its Expedia online travel subsidiary and an $806 million after-tax charge related to investments. That's an improvement on the $2.45 billion in net income reported in the same quarter a year ago.

Earnings per share came in at $0.49, including a $0.15 gain on the Expedia sale and a charge of $0.14 for the investment impairments. Earnings per share last year chimed in at $0.44.

Windows XP shipped on nearly 60 percent of all new PCs sold during the quarter, marking a faster penetration rate than any of Microsoft's previous operating systems, the Redmond, Washington, company said. That helped drive revenue growth of 11 percent from what Microsoft calls its desktop platforms products.

John Connors, Microsoft's chief financial officer, described the revenue growth as solid and said operating results exceeded the company's expectations.

The figures still fell short of expectations, however. On average, financial analysts had been looking for revenue of $7.34 billion and earnings of $0.51 per share, according to Thomson Financial/First Call.

"While we look forward to slightly improved PC growth rates for the next quarter, our expectations for enterprise IT spending levels continue to be quite modest.'' John Connors, chief financial officer at Microsoft, said in the statement.

Revenue from its desktop applications business, which includes Microsoft Office, client licenses for its server products, and products from the Microsoft Great Plains and bCentral divisions, came in at $2.44 billion, basically flat with $2.41 billion a year earlier. Within that group, Office revenue declined slightly because more customers signed up for multi-year licensing agreements, revenue from which is recognized over time, and because consumer purchases were low in Asia, particularly in Japan, the company said.

Revenue from desktop platforms, which include Windows XP, Windows 2000 and other desktop operating systems, climbed 11 percent from a year earlier to $2.29 billion. A greater proportion of customers bought higher priced products such as Windows 2000 and Windows XP Professional, but the gains were partly offset by PC sales, which were flat from a year earlier, Microsoft said.

Revenue from its enterprise software and services division increased 2 percent year-over-year to $1.28 billion. Within that group, SQL Server revenue grew strongly, but .Net server software sales were hampered by "poor economic conditions and weakness in IT investments," the company said. Revenue from tools, training and certification and other services dropped 12 percent.

More than 1 million developers have bought Microsoft's Visual Studio .Net tools since their release, but many bought subscription licenses through Microsoft Developer Network (MSDN), which means some of the revenue will be deferred to later quarters, Connors said.

"Don't confuse our reported results with market acceptance of Visual Studio .Net," he said.

The launch of Microsoft's Xbox helped to lift revenue markedly in its Consumer Software, Services and Devices division, which also includes MSN and Microsoft's mobile and embedded systems software. Xbox sales outside of North America were "a bit below our expectations," Connors said, but still helped to more than double revenue from that group to $1.07 billion, from $460 million a year earlier. Advertising sales from MSN were also strong, he said, thanks in part to a boost in ad spending during the Winter Olympics.

Connors lowered the company's targets for Xbox sales for the fiscal year, which ends June 30, following slower than expected sales in Japan, Europe and Australia. The company now expects to sell 3.5 million to 4 million Xboxes worldwide through the end of the fiscal year, down from its original estimate of 4.5 million to 6 million.

"We had always known that Japan would be the toughest market to break into, and that turned out to be the case," he said.

A price cut on the Xbox in Europe and Australia that was announced earlier Thursday should help boost sales, he said. If the company executes well, it expects to have sold 9 million to 11 million Xboxes worldwide by the end of June 2003, he said.

The company projected financial results for the fourth fiscal quarter, which ends June 30, that were lower than many analysts had been expecting. Revenue is likely to be in the range of $7.0 billion to $7.1 billion, with diluted earnings per share of $0.41 or $0.42, Connors said. Analysts had been predicting fourth-quarter revenue of $7.65 billion and earnings of $0.44, according to First Call.

"IT spending levels are simply lower than we had expected," he said.

He also warned analysts that they may need to trim their operating income and earnings expectations for fiscal 2003 as Microsoft works to expand its business into new areas. Next fiscal year it will spend heavily on research and development for the Tablet PC, mobile products, storage and security, Connors said. It will also expand its sales teams in a bid to reach more small and medium-sized businesses and to sell more server software, he said.

"We are getting ready for an important year in the company's life, a year when we will make some deep commitments to businesses we want to be in for the long term," Connors said. "We feel these investments are key to Microsoft's success and pursuing them is the right thing to do, even if we have to sacrifice some profits in the short term."

Microsoft shares (MSFT) on the Nasdaq closed at $56.37 ahead of the results, down 0.46 percent on the day. In the after-hours markets the stock quickly sank by almost $4.00, but recovered slightly to trade at $54.90 at the time of this report.

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