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Will Microsoft's Miss Be Repeated?

By Jay Greene Microsoft, which historically has hit its sales targets with uncanny consistency, surprised some financial analysts when it missed its own projection for the fiscal third quarter that ended Mar. 31. Three months ago, the software giant said it expected revenue for the period to come in between $9.7 billion and $9.8 billion. But when the company released results Apr. 28, it came up short. Microsoft (MSFT) rang up just $9.62 billion in sales, a 5% increase from the year-ago quarter.

Microsoft doesn't blame the miss on slowing corporate spending (see BW Online, 4/18/05, "Tech's Gathering Gloom"). Instead, it cites a greater-than-expected decline in commercial and retail licensing for its business selling Windows operating systems for PCs, and a drop in currency exchange rates from when the company projected its earlier numbers.

"PUZZLED" BY CURRENCY HIT. The Windows business very likely hurt the overall results. Revenue in the division that sells the operating system for PCs climbed just 2% from the year-ago period, to just below $3 billion. Windows got whacked by a double-whammy. First, the company is selling a smaller percentage of the more expensive Professional version of Windows, compared to the lower-cost Home edition. And Windows sales at retail outlets and through commercial licenses fell 18%.

The foreign exchange rate hit Microsoft across the board. Results in nearly every one of Microsoft's seven divisions fell short of the Redmond (Wash.) concern's own projections from just three months ago.

But analysts weren't sure if they could attribute those drops solely to declining foreign exchange rates. "I'm a little puzzled by that," says Rick Sherlund, a Goldman Sachs & Co. analyst. "That was a little different than what we've heard from other companies."

The software giant's earnings were largely in line with expectations. Operating income hit $3.3 billion, up 160%, though those numbers are skewed by legal settlement costs -- $768 million in the most recent quarter, compared to $2.5 billion in the year-ago period. Earnings per share were 23 cents, including 5 cents of legal charges, compared to 12 cents a year ago, including 17 cents in legal charges.

"NOT A SLAM DUNK." Microsoft shares gained after the results were announced, largely because Redmond projected solid growth in the current quarter. Microsoft expects fiscal-fourth-quarter sales to come in at $10.1 billion to $10.2 billion, a 9% to 10% gain from the fiscal fourth quarter in 2004. Operating income should hit $4.1 billion to $4.2 billion, up 31% to 34%.

But some analysts wonder if Microsoft will hit its mark in the fourth quarter. "It's not a slam dunk that they can do the numbers," said Charles DiBona, an analyst with Sanford C. Bernstein & Co.

He was particularly skeptical about the company's sales projections for Windows for PCs, which Microsoft expects to climb 8% to 9%, a number the outfit bases on the expectation that PC sales will climb 9% to 11% in the period. "That's the one where it's not screamingly obvious how you're going to get to that number," DiBona says. And with Windows such a big piece of Microsoft's overall sales, any miss on that business will hit the company's overall projections disproportionately.

LOOKING GOOD? Indeed, Microsoft expects all of its major businesses to grow more quickly in the current period than they did in the third quarter. It projects that server sales will climb 16% to 17%, up from the 12% growth it posted in the third quarter. The unit that sells the Office software suite should see revenue advance 3% to 4%, according to Microsoft projections, up from the 2% gain it reported in the third quarter.

And the software maker says sales in the home and entertainment unit should climb 20% to 22%, up from the 12% increase in showed in the third quarter. "We're having a healthy year to date, and the outlook looks good," says Corporate Controller Scott Di Valerio.

Microsoft also offered its first guidance for fiscal 2006. It expects revenue to be $43.3 billion to $44.1 billion, a 9% to 11% gain over its projection for fiscal 2005. Operating income should be between $18.3 billion and $18.9 billion.

But those are just projections. And as Microsoft showed in the third quarter, they're sometimes off the mark. Greene is BusinessWeek's Seattle bureau chief

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