Economic gloom once again has descended on Microsoft, which reported disappointing fiscal third quarter results. The sales figures are yet another sign that enterprise spending is down during the recession and that many businesses are holding back major operating system and business application deployments until Windows 7 releases.
Once again, netbook sales sapped Windows Client division profits. More broadly, slower PC and server sales took their toll, too. Windows client revenue declined a stunning 16 percent year over year.
For fiscal third quarter, ended March 31, Microsoft revenue was $13.65 billion, for 6.5 percent year-over-year decrease. Operating income was $4.44 billion and net income was $2.98 billion, or 33 cents a share. If not for two charges, $290 million and $420 million, Microsoft would have met earnings expectations. The charges sapped 6 cents a share from earnings.
The Wall Street consensus was $14.09 billion in revenue with earnings of 39 cents a share. In January, Microsoft refused to offer guidance, as would be typical, because of the weak economy. The previous quarter was Microsoft’s toughest since fourth quarter 2000, during the last recession. While revenue rose 2 percent year over year in the fiscal second quarter, operating income declined 8 percent, net income by 11 percent and earnings per share by 6 percent year over year.
Microsoft last offered fiscal 2009 projections in October: Revenue between $64.9 billion and $66.4 billion, operating income between $24.4 billion and $25.5 billion, and earnings per share between $2 and $2.10. Current analyst consensus: $60.76 billion revenue, which would be a 0.6 percent increase over fiscal 2008. Analyst consensus for earnings is $1.74 per share. Microsoft only offered updated expense guidance for the fiscal year: $26.7 billion to $26.9 billion.
Analysts were generally bearish on Microsoft coming into the quarter, with consensus for a 17 percent growth decline. For the next quarter: 13 percent decline. For the fiscal year: 7 percent. None of this has been good for Microsoft stock, which joined other companies in the spiral downward from September. Share price dropped to a 52-week low of $14.87, but rebounded to near $20 last week. The 52-week high, achieved about a year ago, is $32.10.
Microsoft Business Units Show Mixed Results
Microsoft reported a 15 percent year-over-year decline in new business bookings, largely attributed to global economic malaise. Microsoft reported an even steeper drop in PC unit growth than industry analysts-7 percent to 9 percent year over year.
Microsoft reports results based on five business segments:
– Client, which includes Windows
– Server and Tools, which includes Windows Server
– Business, which includes Office
– Online Services, which includes MSN
– Entertainment and Devices, which includes Xbox
Results by segment:
Windows Client division revenue and income declined in its fiscal second quarter, a trend Microsoft couldn’t reverse in third quarter. Revenue fell 16 percent and income by 19 percent year over year. These are staggering numbers for Microsoft and far exceed unit shipment declines for the broader PC market. The division reported report revenue of $3.4 billion and operating income of $2.51 billion.
According to Gartner, worldwide PC shipments decline 6.5 percent year over year during first calendar quarter. In the United States, shipments declined 0.3 percent year over year. Like the previous two quarters, netbook sales were strong. But the increase in shipments command a high price on average selling prices and, more importantly, margins. Mikako Kitagawa, Gartner principal analyst, predicted that “U.S. mobile PC ASP likely will decline as much as 20 percent year-over-year in first quarter 2009.”
For Microsoft, netbook sales present other problems. The majority of the portables, which analysts call mini-notebooks, ship with Windows XP Home. Retail sales reveal something of the impact: Windows XP had nearly disappeared from U.S. retail PCs in August. By December, Windows XP Home PCs were second to Vista Home Premium, with 13.7 percent market share, according to NPD. Microsoft loses massive margin on every netbook shipped with Windows XP Home. OEMs pay an estimated $50-$60 more per copy of Vista “premium” version. Those numbers are based on analyst estimates; Microsoft doesn’t publicly disclose what OEMs pay for Windows.
Surprising Strength in Server and Tools
But Windows Client numbers are telling enough. Like the previous quarter, declining PC shipments and increasing netbook sales were gravity pushing down Windows Client numbers. Microsoft reported that OEM revenues fell 19 percent, or $637 million, while unit shipments dropped only 6 percent. The difference: Continued decline of premium SKUs, which accounting for only 62 percent of Windows licenses. Netbooks largely account for the shift in mix and difference between OEM revenue and licenses.
Server and Tools
This is Microsoft’s most important line of business during the economic downturn, because, in theory, it is more insulated. Annuity licensing accounts for about 65 percent of sales, offering much greater cushion against slower hardware sales than PCs. Microsoft reported double-digit annuity licensing growth. Year-over-year revenue growth: 7 percent. But income growth was much greater: 24 percent.
Server and Tools revenue was $3.46 billion and operating income was $1.34 billion. The revenue number is simply stunning. For the first time, and in a surprising turn of fortune, Server and Tools revenue topped Client. If the trend continues, Server and Tools would become more important to Microsoft. Considering how much annuity licensing insulates the division from economic hills and valleys, Server and Tools ascension over Client would be good for Microsoft long-term.
Microsoft attributed the 7 percent revenue increase, or $191 million, primarily to growth in client-access licenses for SQL Server, System Center and CAL suites.
Like Server and Tools, Microsoft’s Business division is more insulated from the economy by annuity licensing – but to much less degree. As such, the slowing economy nipped the division, driving revenue down by 5 percent and operating income by 8 percent. Still, Business continued to be Microsoft’s most important division, reporting $4.5 billion in revenue and $2.87 billion operating income.
Business division revenues declined where they were most exposed: outside annuity licensing. Consumer revenue declined a stunning 30 percent, or $299 million. Microsoft mostly attributed the decline to weak PC sales. By comparison, business revenue increased 2 percent, or $73 million. Two problems with business revenue: Dynamics customer billings declined 8 percent, and broader volume-licensing growth reflected past rather than new bookings.
Microsoft’s beleaguered Online Services Group posted yet more dismal results, with revenue down 14 percent year over year and operating income down a whopping 154 percent. Online advertising revenue declined 16 percent, spurred on by declining display ad rates. Online advertising declined by $98 million to $521 million.
Entertainment and Devices
E&D delivered surprising results. While revenue dropped 2 percent year over year, operating income was flat. These numbers are surprising because Xbox console sales grew about 30 percent, or 1.7 million consoles sold in the quarter. Xbox typically drives up revenue while sapping operating income. For the quarter, revenue reached $1.56 billion for an operating loss of $31 million.
Microsoft’s Macintosh Business Unit is part of Entertainment and Devices. In the past Mac sales have been good to Microsoft, but not during fiscal third quarter. Mac application software sales dropped a stunning 63 percent, in part because of the year-over-year comparison to the launch of Office 2008 and also because of declining Mac computer sales.
Joe Wilcox is editor of Microsoft Watch.