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Microsoft's Profit Hurt by Vista Delay, But Shares Climb

CNBC.com
Friday, 26 Jan 2007 | 9:18 AM ET

Microsoft shares got a bounce after the software maker posted fiscal second-quarter earnings that fell sharply but still managed to beat analysts' forecasts.

The long-delayed launch of the Windows Vista computer operating system was largely to blame for the 28% drop in profits that Microsoft reaped in the last three months of the year. Earnings fell to $2.63 billion, or 26 cents per share, from $3.65 billion, or 34 cents per share, during the same period last year.

Analysts polled by Thomson Financial expected the Redmond, Wash.-based software maker to make 23 cents per share.

Revenue rose to $12.5 billion, a 6% gain from $11.8 billion in the year-ago quarter. Analysts were expecting just shy of $12.1 billion.

"Overall, it was a strong quarter," said Robert Breza, an analyst at RBC Capital Markets.

After closing at $30.45 on the Nasdaq Stock Market before the earnings release, Microsoft shares gained 55 cents, or 1.8 percent, to $31 in extended trading.

Hit Market Tuesday

Windows Vista and Office 2007, the latest editions of Microsoft's flagship products, do not hit the consumer market until Tuesday, though they have been available for businesses since Nov. 30.

As a result, Microsoft's "client" division, responsible for Windows, posted a 25% drop in sales to $2.59 billion. And the business division, which includes Office, saw a 5% drop to $3.51 billion.

The declines were expected, because Microsoft heavily deferred Windows and Office revenue from the second quarter to the current period. That was done to account for coupons that recent computer buyers got to let them upgrade their existing software to Vista and Office.

The deferrals trimmed $1.64 billion from Microsoft's second-quarter revenue and $1.13 billion, or 11 cents per share, from profits. If not for the deferrals, Microsoft said revenue would have leaped 20% in the quarter.

"That's impressive growth for any company, let alone one of our size," Chief Financial Officer Chris Liddell said in a conference call.

Previously, Microsoft had said the deferred revenue would be around $1.5 billion. Analysts interpreted the higher result as a sign that more consumers than expected snapped up new PCs, meaning the upgrade coupons helped stimulate demand.

Previous evidence of PC demand had been murky. Two leading analyst firms, Gartner and IDC, reported last week that PC sales in the end-of-year quarter rose roughly 8% worldwide but declined in the U.S.

Early Level of Interest

"The deferred revenue number for Vista is pretty good. It gives us some sense of the early level of interest in Vista," said Sid Parakh, an analyst at McAdams Wright Ragen.

Microsoft's overall revenue gain was greatly helped by the entertainment and devices division, which includes the Xbox 360 video game console and "Gears of War," December's top-selling game, according to market researchers at NPD Group. The entertainment division's revenue hit $2.96 billion, a 76 percent jump.

The unit lost $289 million, however, roughly even with last year. And Liddell said Microsoft was cautious about where Xbox goes from here. He expects that by June, the company will have sold 12 million Xbox 360 consoles, down from previous guidance of 13 million to 15 million.

Also in that division is Microsoft's Zune music player, which hit the market in mid-November to soft reviews. Liddell said the company remains confident it can sell 1 million Zunes by the end of June.

Microsoft's server division, which sells software for corporate data centers, was the other standout performer. Its revenue leaped 17% to $2.85 billion, while its profits rose 35%.

Liddell predicted "an excellent year" for Microsoft and slightly increased growth predictions for the crucial client division. But he appeared to give analysts little reason to alter their overall estimates.

In another closely followed portion of Microsoft's business, Liddell said Web advertising revenue should grow in the mid-teens this year. Last summer, Microsoft moved online ad operations to its own platform, adCenter, away from Yahoo Inc.'s Overture. Liddell said revenue from ads placed next to search results on the MSN and Live sites grew for the first time since the transition.

Still, Microsoft isn't expected to close the search-ad revenue gap with Google or Yahoo anytime soon. ComScore Networks found that in December, Microsoft sites performed 10.5% of all U.S. Web searches, down from 14.3% a year earlier.

"We're clearly not happy with that," Liddell said.

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