Microsoft profit up, but forecast is cut

Microsoft cut its financial targets and vowed to slow hiring and trim spending for the rest of the business year to account for the struggling economy.

In reporting the company's fiscal first-quarter financial results Thursday, Chief Financial Officer Chris Liddell said earlier forecasts, issued in July, were based on the expectation that the economy would improve in the first six months of 2009.

"This clearly now appears unlikely to occur," Liddell said.

Microsoft reduced its forecast for sales, operating income and earnings per share, even as it reported strong sales and profit in its fiscal first quarter, ended Sept. 30.

"We continue to forecast outgrowing the market regardless of the economic conditions," Liddell said.

The impact of the credit crisis and market uncertainty didn't hit Microsoft until the last few weeks of September, but they have persisted through October, he said.

First-quarter sales topped $15 billion, up 9.4 percent from the previous year, led by Microsoft Office and server software. Profit was $4.4 billion, up 2 percent, and earnings per share grew 6.7 percent to 48 cents, beating Wall Street analysts by a penny.

After an up-and-down-and-up day of trading, Microsoft's stock gained in extended trading after the results were released, but ultimately finished down slightly to $22.11. It had closed regular trading at $22.32.

While the company performed well in the quarter, analysts were concerned by sluggish growth in the all-important Windows business, which Microsoft calls the "client" segment for financial-reporting purposes.

Sales increased 2 percent to $4.2 billion, which was 4 percentage points lower than company forecasts. For the full fiscal year, Microsoft expects the segment to grow 2 to 6 percent.

"I think the magnitude of the pullback in their flagship client business is pretty striking," said Brent Thill, director of software research at Citi Investment Research. "... It is the cash cow."

The primary driver for the client business is growth in PC shipments, because Windows runs the vast majority of the world's computers. In the September quarter, Microsoft estimates the PC shipment growth rate was 10 to 12 percent, which is lower than the estimates of market researchers Gartner (15 percent) and IDC (15.8 percent).

Despite that relatively strong growth, two trends in the PC market contributed to lower average prices for Windows.

First, PC growth is faster in emerging markets where prices are lower to begin with, piracy rates are higher and open-source alternatives to Windows have more traction.

Second, a new category of low-cost mobile PCs, sometimes called "netbooks," exploded onto the market. This category outpaced more expensive computers, which are usually sold with higher-end versions of Windows, producing a higher profit margin.

Starting about a year ago with manufacturer Asus, many computer makers have marketed machines primarily meant for browsing the Internet and checking e-mail. They typically cost less than $500 and use lower-cost versions of Windows or Linux-based operating systems.

"The cash cow just got deprived of some growth opportunity," Thill said.

Because the netbook category is still relatively new, it's unclear whether it will cannibalize more expensive PC sales in the long run. In mature markets, some analysts expect these low-cost systems to be added as a second or third home computer.

Liddell said Microsoft expects "significant variability" in PC shipments for the rest of the fiscal year. The company is estimating growth of 8 to 12 percent, with "netbooks" representing perhaps 5 percentage points of growth.

Another factor affecting Windows: At the end of the June quarter, PC manufacturers' inventory was high, which contributed to slower sales in the September quarter, as companies tried to avoid being overstocked ahead of what's expected to be a slow holiday shopping season.

Microsoft is trying to balance the right level of long-term investment with more immediate cost cuts to protect its bottom line.

"In the near term, we're reassessing our business plan and pulling back spending in lower-priority areas," Liddell said.

He aims to cut $400 million to $500 million in operating expenses in the current year through slower hiring, reduced capital spending, particularly on the large data centers that power Internet services, and cuts to travel budgets and vendor services.

Liddell also foreshadowed a slowdown in Microsoft's voracious appetite for office space. "We will probably also slow our growth in some of the facilities that we have for people, just by virtue of not having as many people as were expected, as well," he said, adding that's likely to show up in the company's 2010 fiscal year, beginning July 1, 2009.

The company has planned other unspecified cost-saving measures "that we can either dial up or down as we see economic changes unfold," Liddell said.

Unlike some technology companies, Microsoft is not planning layoffs — only slower growth than it was expecting a few months ago — and there is no hiring freeze, said Frank Brod, Microsoft's chief accounting officer.

Some of Microsoft's businesses have had more success hiring in a down market, putting them ahead of their plans, Brod said, "so you may see some pauses as they assimilate the folks into Microsoft."

The planned spending cuts on data centers surprised analyst Allan Krans, of Technology Business Research.

"It seems like that's really part of their core strategic direction for the next 10 years," he said, referring to the company's Online Services Business, which includes Internet search. The company's online advertising revenue grew 15 percent in the quarter, but it has struggled to gain market share from search leader Google.

Benjamin J. Romano: 206-464-2149 or bromano@seattletimes.com