Microsoft’s revenue falls short of forecasts, tough time ahead

"Going into this, the assumption was that growth would accelerate in fiscal 2001 around the Windows 2000 product cycle," said Drew Brosseau, an analyst with SG Cowen in Boston. "Now, they’re backing off that assumption."

Still, earnings were up strongly over last year: Microsoft reported net income of $2.39 billion, or 43 cents a diluted share, up 24 per cent from the year-earlier mark of $1.92 billion, or 35 cents a share. Wall Street analysts had expected profit of 41 cents a share, according to First Call/Thomson Financial. Revenue was $5.66 billion, up 23 per cent from $4.6 billion last year.

A Little Bigger Shortfall: "It’s a little bigger shortfall than even we forecast last week," said Goldman, Sachs & Co. analyst Rick Sherlund, who lowered his revenue estimate last week for Microsoft by about $200 million – to $5.75 billion – in light of slowing demand for corporate PCs. Much of the slowness stemmed from companies’ holding back on new computer purchases because they had already bought new machines to prepare for year-2000 systems glitches – or were afraid of encountering problems if they bought machines too close to January 1. Corporate sales have a strong impact on Microsoft’s revenue and profit, since business-oriented products such as Windows 2000 cost much more than consumer systems.

In addition, analysts noted that Microsoft’s bottomline got a lift from a big, $442.5 million realised gain on its investment portfolio, which accounted for about 4 cents a share of Microsoft’s profits. Total investment income was $885 million.

In an interview, the company’s chief financial officer, John Connors, said the gains shouldn’t be regarded as unusual, because "people should look at those investment gains as something that will be recurring next quarter, that should be recurring in fiscal year 2001, and fiscal year 2002."

Microsoft often invests in companies with which it has strategic relationships, such as telecommunications companies and even retailers, Connors added. Bob Herbold, Microsoft’s chief operating officer, called the investments "an integral part of the business; … you shouldn’t view it as some type of mutual fund that we just sort of watch separately."

But analysts have a hard time predicting such gains, which reflect stock-market conditions, management’s own decisions and other factors. As a result, they say, bottom-line performance can be obscured. As Sherlund noted, "had it not been for that unusual, four-cent gain, the results would have come in two cents light of Street expectations."

The results were issued after the close of trading on the Nasdaq Stock Market Thursday. In 4 pm Nasdaq trading, Microsoft rose 25 cents to $78.9375. It then slid sharply to $74.75 in after-hours trading.

Windows 2000 Shipments: Overall, the earnings represent "a respectable number," said David Readerman, an analyst with Thomas Weisel Partners in San Francisco. But they prompt "some caution about Microsoft’s dependence on PC-desktop unit shipments," he said, "and raise the question as to when and where the revenue pickup for the higher-priced Windows 2000 server shipments will kick in."

Connors said Microsoft has already shipped 1. million units of all varieties of Windows 2000 and is enthusiastic about future growth. "We did see a pickup in business-PC demand late in March," he said. As for businesses switching to Windows 2000, "we will see it," he promised.

Nonetheless, Connors, with caution typical of quarters past, said in a statement that he remained "guarded" about near-term corporate computer demand. On a conference call with analysts and reporters, he also said revenue next year would probably grow at a rate in the midteens, slightly lower than many analysts had been expecting.

Earlier in the week, by contrast, PC chip maker Intel Corp. had said computer demand was stronger than it expected. The apparent contradiction, Connors said, may partly reflect Microsoft’s emphasis on sales to business, where Intel was looking more at the whole market. Intel also restocked its inventory last quarter to compensate for a previous chip shortage, he said.

Microsoft’s core "platforms" business, which includes sales of all versions of Windows, grew 14 per cent from last year – and wound up being the slowest – growing of Microsoft’s three major business lines.

Sales of software applications and tools, including the best-selling Office suite, grew 32 per cent, while revenue from the consumer group surged 26 per cent. That business, by far the tiniest of the three, includes the MSN Internet service, WebTV, Microsoft’s hot computer-games division and some other sales.

In Between Product Cycles: But analysts said they weren’t surprised by the moderate growth in Windows, since they didn’t expect Microsoft to get a big kick from Windows 2000 sales right away. That is mainly because Windows 2000 is targeted at businesses, which take more time buying computer systems than consumers.

"In the enterprise-software world, people don’t line up at a software store at night and buy 100 copies for their department," said Melissa Eisenstat, an analyst with CIBC World Markets in New York. Right now, Microsoft "is kind of still in between product cycles."

Eisenstat pointed out that revenue from the platforms group grew just 6 per cent in the quarter ended December 31, far less than this quarter’s growth.

But "there is no question that in the grand scheme of things, the PC industry is getting more mature" and isn’t growing as quickly as it once did, said Brosseau, of SG Cowen.

Analysts also noted that overall revenue growth looked larger than it really was, because Microsoft didn’t book about $400 million in sales from its Office software in last year’s third quarter, lowering last year’s revenue number. Instead, Microsoft deferred that revenue – which it traditionally refers to as "unearned revenue" – and accounted for it over subsequent quarters.

The sales stemmed from coupons that customers got last year to upgrade to the newer Office 2000 suite. Sherlund of Goldman Sachs said revenue growth would have been about 13 per cent, instead of 23 per cent, if the $400 million from the coupons was added back into last year’s sales number.