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Originally published July 24, 2009 at 12:00 AM | Page modified July 24, 2009 at 12:11 PM

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Economy roughs up Microsoft optimism on Wall Street

Microsoft scraped along the bottom of the economy, weighed down by poor sales of personal computers and servers, reporting a drop in sales and profit in its fourth quarter.

Seattle Times technology reporter

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Microsoft scraped along the bottom of the economy during the spring and early summer, weighed down by poor sales of personal computers and servers.

In its earnings report for its latest quarter and the fiscal year, the company reported Thursday that revenue fell in every business division. Total revenue for the quarter, $13.1 billion, was $1 billion below what analysts had forecast.

The report made clear that the Microsoft growth engine has sputtered and stalled. The 12 months that ended on June 30 marked the first fiscal year in the company's history that saw sales fall, a 3 percent decrease to $58.44 billion.

Compare that with the period from fiscal 2002 to 2008, when revenue more than doubled, from $28.37 billion to $60.42 billion.

"Our absolute results were disappointing due to the poor macroeconomic environment," Chief Financial Officer Chris Liddell said in a conference call with analysts. "We are a stronger company than we were a year ago; however, the economy continues to be challenging and we have to lift our game to another level in 2010."

Sarah Friar, an analyst with Goldman Sachs, called Microsoft's sales numbers a "big disappointment."

The stock fell in after-hours trading to as low as $23.31, a 9 percent drop from the day's closing price of $25.56.

By reducing expenses, the company was able to come close to profits analysts had hoped for — earning $3.05 billion for the quarter. The company made a profit of 36 cents per share, or 34 cents if one-time legal costs and investment impairments are counted in.

"In light of what revenues did, it did seem like cost control was pretty good," said Sid Parakh, analyst at Seattle-based McAdams Wright Ragen. "So in the context of lower revenue, profitability was fine."

Still, profit for the quarter that ended on June 30 was 29 percent lower than the same quarter a year ago.

The only prediction Microsoft would make on future financial performance was that it expected to keep operating expenses to between $26.6 billion and $26.9 billion for the year. In its fiscal fourth quarter, Microsoft cut $900 million in operating expenses below costs in the third quarter.

The company did not comment on whether it expected any more job cuts. Microsoft went through its first major layoffs this year, cutting close to 5,000 jobs.

"There are some signs we have at least seen the worst," Liddell said. He noted that Windows and Windows Server sales increased from the third to the fourth quarter, the first time that had happened since September.

But he did not expect the economy to improve this year. "We see potential for improvement in calendar 2010," he said. "But timing is uncertain."

Delving deeper into the performance of each business division, there was little to spark immediate optimism.

"Where it was weak, it was weak across the board," Friar said. "It was just general in every division. You saw that macro impact continue to weigh on each division."

Sales in the Client division, home to the Windows business, trailed the PC market, falling 22 percent in the fiscal year, even though the traditional PC market (not including briskly selling small, cheap netbook computers) was down only 15 to 16 percent. Including netbooks, PC market sales have slowed 5 to 7 percent, according to company estimates.

Client sales were $3.11 billion during the latest quarter, compared with $4.36 billion a year ago, and operating profit in the division fell from $3.25 billion to $2.17 billion.

"We've seen substantial weakness in business PC market as reduced IT budgets have delayed hardware purchases and refresh cycles," Bill Koefoed, general manager of Microsoft investor relations, said during the earnings call.

The company hopes that Windows 7, the new operating system set to launch Oct. 22, and a new business budget cycle in 2010 will lead to a sales revival. Liddell even suggested that Windows sales could outpace sales of traditional PCs by June of next year.

The Server and Tools division, which sells server software, fell 6 percent compared with the same quarter a year ago, which the company said was in line with the sales of server hardware.

Server sales in the quarter dropped slightly to $3.51 billion from $3.72 billion, while operating profit also edged downward from $1.37 billion to $1.35 billion.

The Online Services business, which includes the new search engine Bing, continued to lose money — $732 million compared with $485 million in the quarter a year ago. Sales also fell, from $837 million to $731 million. The company blamed the drop in sales on a decline in display-advertising rates.

Microsoft did not comment on a potential partnership with Yahoo. The companies are rumored to be in discussions about a possible search relationship.

The Entertainment and Devices division, which includes Xbox and music player Zune, saw sales fall to $1.19 billion from $1.59 billion, but its operating loss narrowed to $130 million from $171 million.

The Business division, which includes Office software, saw sales fall to $4.56 billion from $5.27 billion. Operating profit fell to $2.82 billion from $3.36 billion. The company does not expect a rebound in the business until fall of 2010, when a new version of Office software is expected to be ready.

Across the company, one-time expenses during the quarter included $193 million of legal charges, $108 million of investment impairments and $40 million in severance paid to employees during layoffs.

About $276 million in revenue earned from the Windows 7 upgrade program during the quarter will be deferred until the software launches in October.

Sharon Pian Chan: 206-464-2958 or schan@seattletimes.com

Copyright © 2009 The Seattle Times Company

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