Microsoft's Profits Down, Shares Up

Microsoft Corp. custodial workers prepare signs promoting the upcoming release of the Windows Vista computer operating system Thursday, Jan. 25, 2007 at a company cafeteria in Redmond, Wash. AP

Microsoft Corp. shares got a little bounce after the software maker posted fiscal second-quarter profits 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 percent 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 percent 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.

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 percent drop in sales to $2.59 billion. And the business division, which includes Office, saw a 5 percent 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 percent 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 percent worldwide but declined in the United States.

"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 percent to $2.85 billion, while its profits rose 35 percent.

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 the current quarter, Microsoft predicts earnings of 45 cents to 46 cents per share on $13.7 billion to $14 billion in revenue, helped by the deferrals from the second quarter. Analysts already were expecting 46 cents per share and $14 billion in revenue, according to Thomson Financial.

For the full fiscal year, which ends June 30, Microsoft foresees earnings of $1.45 to $1.47 per share, with revenue of $50.2 billion to $50.7 billion. That was slightly ahead of the estimates already held on Wall Street: $1.45 per share and revenue of $50.5 billion.

For the first half of its fiscal year, Microsoft earned $6.1 billion, or 61 cents per share, on revenue of $23.4 billion. In the comparable period a year earlier, Microsoft's profit was $6.79 billion, 63 cents per share, with revenue of $21.6 billion.

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 Inc. or Yahoo anytime soon. ComScore Networks Inc. found that in December, Microsoft sites performed 10.5 percent of all U.S. Web searches, down from 14.3 percent a year earlier.

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

By Brian Bergstein

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