Microsoft CFO calls XP a long-term investment

The multimillion-dollar marketing blitz that Microsoft Corp. embarked on to introduce its new Windows XP operating system reached a pinnacle Thursday as executives from the world's largest software company unveiled the new software at a series of events around the world.

Though the glitzy rollout is notable for its price tag, analysts expect it to do little to encourage businesses and consumers who are holding tight to their pocketbooks to buy the new software.

"We've tried to be realistic and conservative about what we expect from our new products," said John Connors, Microsoft's chief financial officer, in an interview with IDG News Service Thursday following the company's Windows XP launch in San Francisco. Any widespread adoption of Windows XP "really depends on when the consumer PC market gets back into positive growth," he said.

With PC growth forecast to be flat or even decline in the current fiscal year, according to Microsoft's own estimates, it is more likely that Windows XP will secure the company's foothold in the desktop software market when the economy recovers and give it a market advantage when the promise of Internet-based computing comes to fruition.

"They're really not expecting too much from Windows XP in the next couple of quarters," said Don Young, an analyst with UBS Warburg, the U.S. investment arm of Switzerland's UBS AG. Young says any lackluster sales could be attributed to the waning economy. "They've set the bar really, really low."

Microsoft is taking a long-term approach with Windows XP, despite the hype that accompanied Thursday's release. In the corporate market, the company is still pushing customers to complete their upgrades to Windows 2000, currently the biggest revenue driver for Microsoft's platforms division. In the consumer market, Microsoft is sitting tight until the economy rebounds.

Right now, that rebound is a difficult thing to predict. In its conference call to discuss its fiscal 2002 first-quarter earnings, Microsoft lowered its full-year financial forecast and revised its expectations for worldwide PC shipments. Following a weak quarter ended Sept. 30 and the unraveling effects of the Sept. 11 attacks on the world economy, Microsoft cut expectations to flat or negative growth in PC shipments, from earlier predictions of single-digit growth.

"We did moderate expectations a little bit. But they are forecasts we feel comfortable with." Connors said, joking that "Bill (Gates) and Steve (Ballmer) don't really pay attention to quarterly results."

While also looking to the long-term vitality of the industry, analysts say the PC market is in for more than just a moderate decline. Worldwide shipments are expected to decline as much as 13 percent in the fourth calendar quarter of 2001 -- Microsoft's fiscal second quarter -- compared to the fourth quarter of 2000, according to research from Stamford, Connecticut-based Gartner Inc.

That will translate into slimmer times for the Redmond, Washington, software maker, which traditionally has depended on sales of its operating systems and desktop software for the bulk of its revenue.

In the fiscal first quarter of 2002, Microsoft took in more than $2 billion from sales of its desktop operating systems, nearly one-third of the total $6.1 billion revenue it reported that quarter. Sales of those operating systems -- which include Windows 2000 Professional, Windows NT Workstation, Windows ME, Windows 98, and earlier releases -- grew 7 percent as a whole from the year-earlier quarter. However, the company saw a decline in revenue from Windows 98 and Windows ME sales, it said.

Its desktop applications revenue has been even harder hit. Despite the release of its highly publicized Office XP productivity suite during the first fiscal quarter of 2002, Microsoft saw only a 2 percent increase in revenue on the sale of desktop applications compared to the same quarter in 2001. Consumer sales of Office software actually declined despite heavy marketing for Office XP, the company said.

Although the company is expecting similar adoption rates with the release of Windows XP, Connors said it will be some time before the new Windows platform inches its way on to the majority of PCs.

"Clearly the opportunity for Windows XP, as retail sales go back up, is better than it is for Office," Connors said. He noted that customers have traditionally had more of a tendency to upgrade operating systems than office applications.

According to a report from Gartner released Thursday, Windows XP isn't expected to make significant inroads into the corporate PC market until 2003, though Home edition customers will move to the operating system next year.

"When people begin to buy consumer PCs in larger volume they will have Windows XP on them," Connors said.

Looking forward, however, Microsoft is working to address its reliance on desktop software sales. The company has already revised its enterprise licensing options so that it can keep its customers running the most current versions of its software. Analysts say that change will increase what many companies currently spend on Microsoft products. It is also shifting its business to one that relies on products and services being delivered in bytes, not discs.

Windows XP is only the first piece of several to come from the company as it delivers its .Net initiative more broadly. Already the company has released much of its .Net enterprise server software in a move to lay the foundation for .Net. Within two years, Microsoft said it expects to release an upgrade to Windows XP, code-named Longhorn, which will include more .Net underpinnings.

With that operating system incorporating more of the .Net Framework into the desktop, the server software building out the infrastructure, and Microsoft's extension of .Net to the Web with its MSN network of software and services, it will transform how the company makes money. Microsoft will evolve from a traditional software seller into a service provider, delivering its products in much the same way as cable TV providers, analysts and other industry observers say.

Tuesday, Bob Muglia, Microsoft's vice president in charge of .Net services, unveiled some details of how the company plans to make money from this services model. He detailed how it will charge companies to use its Web services building blocks, called .Net My Services, for building their own Web services. He also explained how consumers will pay for .Net My Services through subscriptions when it is released in full next year, with MSN and the Office software as the central points for distributing services to consumers.

"The PC market is maturing, so they need to look elsewhere for mature market types of growth," said Charles Dibona a financial analyst with Sanford C. Bernstein & Co. LLC in New York. "I think initially you're going to see .Net revenue show up in the enterprise space. You're already seeing traction in sales of .Net components. If that gets traction, later on we'll start to see revenue from services."

USB Warburg analyst Young agreed, predicting much of the initial growth to come from the sale of the software necessary to build an infrastructure for building and deploying Web services. "The way they'll make money in the long term is to sell more server software," he said.

In the meantime, although the current economic climate is expected to make adoption of Windows XP sluggish, Microsoft hasn't changed any of its plans to roll out more advanced products in the next few years. And with more than $30 billion of cash in its coffers, analysts say, the company has room to continue innovating.

"Today, .Net My Services is a huge financial piece in terms of (research and development spending)," Connors said. "In terms of it having a material impact on financial guidance, we haven't forecasted that yet."

The company's analyst meeting next year will focus on more details of its business plans around .Net and its Web services products, he said.

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