Microsoft Profits Slump Despite Record Revenue

As it awaits the release of Windows Vista, Microsoft on Thursday posted a second quarter that saw sharply lower earnings for a period marked by continued growth in its entertainment division and little progress in its efforts to catch up with Google on the online search front.

For the quarter that ended in December, the company said revenue was a record US$12.54 billion, up 6 percent over a year ago. Net income was $2.63 billion, 28 percent lower than income reported at the end of 2005.

That drop was due mainly to the deferral of $1.64 billion of revenue and $1.13 billion of net income to the upcoming third quarter.

Coupon Program

Those deferrals reflect Microsoft’s coupon program, which gives consumers who purchased new PCs in the holiday season a free upgrade to Windows Vista and Office 2007 when they becomes available in the next two weeks.

Still, the results managed to edge past most analysts’ forecasts. Microsoft shares got a modest boost from the results, with shares up about 1 percent in morning trading Friday to $30.76.

The results “exceeded our expectations across the board, with revenue growth at or above our high end guidance for all divisions,” said chief financial officer Chris Liddell, adding that “healthy PC and server markets” and “broad-based business and consumer demand for Microsoft offerings” drove sales growth.

Microsoft said it saw a 30 percent jump in revenue from its SQL Server software line for enterprises.

It also kept its forecast in line with earlier projections, though some analysts were quick to point out a reduction in the estimates for total Xbox sales for the current fiscal year. Microsoft now says it will sell around 12 million of the gaming consoles by the end of June, down form an earlier forecast of between 13 million to 15 million.

Mixed Bag

Microsoft’s entertainment unit, which sells both the Xbox gaming console and the Zune digital music player released late in the year, showed strong growth, with 75 percent year-over-year revenue expansion.

However, the unit continued to be a money loser, with a net loss of $289 million, up just slightly from the year before.

Little information was given on how well the Zune fared in the quarter.

If Microsoft’s entertainment unit is growing rapidly, online services put up a much more sluggish performance. Revenue in that unit grew by 5 percent, but the division turned in a loss of $155 million, compared with a modest profit a year ago.

In fact, Microsoft’s search engines appear to be losing market share. Data released this week from comScore Networks found that Microsoft sites captured 10.5 percent of the 6.7 billion searches conducted in December, down from 11 percent the month before. Market power Google, meanwhile, saw its share of searches grow from 46 to 47 percent.

Liddell noted that revenue per search appeared to be on track to remain at current levels and reiterated Microsoft’s claim of taking a “long-term view” of the search opportunity. Microsoft has said it would take several years before it would become a more formidable rival to Google.

Microsoft said that it expected to see 3 to 8 percent growth in revenue from its Internet services division.

Views on Vista

The deferred revenue could be good news for investors by promising to help smooth out seasonal slowdowns and keeping revenue strong in coming quarter. On the other hand, the outlook from Microsoft suggests no immediate surge in PC sales, which could be bad news for PC makers.

Microsoft and the PC industry may just have to wait a little longer to see the full bang from the Vista launch, Enderle Group analyst Rob Enderle told the E-Commerce Times.

Though interest appears modest so far, “The consumer campaign has yet to kick off, and I do think there is enough good in the product to drive adoption above the normal PC cycle rate,” he said. “For corporations, the security and usability improvements coupled with the normal replacement cycle should cause it to roll to that market in large volume next year. This year, it will be largely small business and consumer.”

Vista-loaded PCs could be hot sellers in the back-to-school and holiday seasons, though earlier jumps around tax-rebate season, for instance, can’t be ruled out, Enderle said.

Also not clear is how well Microsoft’s devices are stacking up. While Xbox sales had been robust and the Xbox 360 widely considered a top-shelf device, Microsoft’s numbers don’t give insight into how well the product is selling in stores.

If nothing else, the Nintendo Wii and the PlayStation 3 were far more in demand in the holiday season, in part due to their relative scarcity.

In time, Microsoft may also get some push-back from its PC-maker partners, Enderle noted, because with Internet connectivity, DVD-playing capacity and other features, the Xbox is coming close to being a replacement for full-blown personal computers for some consumers.