The Windows Observer--Record Revenues for Microsoft, But Forecast Downgraded

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Volume 5, Number 17 -- April 30, 2008

Record Revenues for Microsoft, But Forecast Downgraded

Published: April 30, 2008

by Alex Woodie

Microsoft reported record revenue of $14.45 billion for its third quarter ended March 31, citing strong demand for its Windows Server and SQL Server products. But an 11 percent decline in operating income and weaker than expected guidance for the current quarter combined to make investors wary.

Microsoft's revenue inched upward by $56 million (or less than one percent compared to the third quarter of 2007) to set a new third quarter record, while net income dropped to $4.4 billion from the $4.9 billion it reported a year ago, and diluted earnings per share dropped to $.47 per share from $.50 per share.

However, those profit numbers from a year ago take into account the technology guarantee that Microsoft put into place to prop up Windows sales in lieu of Windows Vista. Without the guarantee, revenue for the current quarter increased by 14 percent and diluted earnings per share increased by 27 percent, indicating solid execution for Microsoft.

Microsoft's earnings took into account the $1.42 billion fine levied by the European Commission, which corresponded to $0.15 per share. However, that loss was entirely offset by a resolution of an income tax audit with the federal government, which added $.15 per share to the bottom line.

But it was Microsoft's softer-than-expected forecast that led investors to a sell off that dropped the company's stock by nearly $2, or more than 6 percent, immediately following Microsoft's earnings announcement last Thursday. Since then, it has lost another 3 percent.

For the current quarter, the company said it expects earnings in a range of 45 cents a share to 48 cents a share. That's on the low end of analysts' expectations, which averaged 48 cents a share. A revenue forecast of $15.5 billion to $15.8 billion was similarly on the low end of analysts' average estimate of $15.6 billion.

A division-by-division breakdown of Microsoft's results displays the company's strengths and weaknesses. The Client Division, which is responsible for development of the Windows operating system, reported revenue of $4.0 billion for the quarter, a 24 percent drop from $5.3 billion recorded a year ago. When the technology guarantee is removed from the equation, the decline was only 2 percent.

The Client Division also suffered a bit due to a decline in the rate of growth of PC sales. PC unit sales were smoking during the second half of 2007, increasing 13 percent. That slowed to 8 to 10 percent during the first quarter, as a result of seasonal buying patterns as well as the worsening U.S. economy.

Strong sales of Windows Server products, SQL Server, and multi-year enterprise agreements worked to boost the Server and Tools Division's revenues by 18 percent, to $3.3 billion. It was the 23rd consecutive quarter of double-digit revenue growth for this division, the company says.

Online Services, which includes Windows Live and MSN, brought in $843 million for the quarter, a 40 percent increase from a year ago. A good chunk of that growth has to do with ad sales brought in through the new aQuantive business.

Microsoft Business Division, which sells the Office productivity suite and ERP products, accounted for $4.7 billion of the company's revenue, resulting in a 2 percent drop from a year ago. However, without the technology guarantee clouding the picture, MBD would have reported a 9 percent revenue increase. Microsoft says billings are especially strong within its Dynamics ERP and CRM software segments, which increased 13 percent.

The Entertainment and Devices Division brought in $1.6 billion during quarter three of 2008, a 68 percent jump from the third quarter of fiscal 2007, thanks entirely to strong demand for its Xbox 360 game consoles.