Vista Pays Off for Microsoft

Despite rumblings to the contrary, sales of the new operating system led to big revenue gains for the quarter and raised hopes for the year to come

In the weeks before Microsoft's quarterly earnings release, reports abounded of security problems with the new Windows Vista operating system. And talk was rife that myriad software programs don't work well with Vista. It was enough to give the impression that Vista, launched in January, wasn't selling all that well. Microsoft's fiscal third-quarter results, reported Apr. 26, paint a different picture.

Revenue in Microsoft's (MSFT) Client Division, consisting primarily of Windows sales for PCs, hit $5.3 billion, a 67% jump over a year earlier. That includes $1.2 billion in deferred revenue from presales of Windows Vista, money paid by customers before the quarter started but not counted in results until the product shipped. But even without that spike, the group's sales climbed 17%. In other words, Vista sales growth topped Microsoft's estimates of overall PC unit sales growth, which came in between 10% and 12%. That's largely because 71% of customers opted for the high-priced premium editions of Vista.

And while some corporate customers still opt for the predecessor Windows XP when they buy new computers, for software compatibility reasons, a remarkably large number are taking the new operating system. Microsoft says 85% of Windows sales are Vista, outpacing sales of XP at the same time in its life cycle.

Beating Expectations

Vista wasn't the only new product that powered results. The 2007 Microsoft Office system, the group of products led by the new Office productivity software, which launched alongside Vista, posted surprisingly strong numbers. Sales in the Microsoft Business Division, consisting largely of Office, hit $4.8 billion, a 34% gain. Like Windows, Office benefited from about $500 million in deferred sales. But even without the bump, the division's sales would have jumped 20%. "We exceeded our revenue expectations by about $200 million," Microsoft Chief Financial Officer Chris Liddell said during a conference call discussing results.

Vista and Office gains translated to a quarter that surpassed Microsoft's earlier forecast and analysts' expectations—and they augur stronger results this year and next than Wall Street was predicting. Microsoft increased its guidance for the fourth quarter and suggested that results in fiscal 2008 might come in ahead of analyst projections.

The company now expects to report fiscal 2007 sales of $50.9 billion to $51.2 billion, up 15% to 16%. Just three months ago, Microsoft was guiding to a more conservative $50.2 billion to $50.7 billion in sales. The company now expects earnings per share for the fiscal year to land between $1.48 and $1.50, up from its earlier guidance of $1.45 to $1.47. Microsoft also offered up its first guidance for fiscal 2008: The company expects $22 billion to $22.5 billion in operating income on sales of $56.5 billion to $57.5 billion. Earnings per share should come in between $1.68 and $1.72.

This guidance comes on top of a quarter that Liddell says left him "extremely pleased." For the period, operating income climbed 69%, to $6.6 billion on sales of $14.4 billion, a 32% gain. The deferred revenue goosed the top line with an extra $1.7 billion and boosted net income by $1.1 billion. Even without those gains, revenue would have climbed 17%, remarkable for a company Microsoft's size.

Searching for Market Share

The only real blight came in the online services group, the division that competes head-on with Google (GOOG). But even there, Microsoft's fortunes look brighter. The company continues to trail Google in Web-search market share. But it seems to have reversed the slide, garnering 10.1% of U.S. searches in March, up from 8.9% in January, according to market research firm Nielsen//NetRatings (NTRT) (see, 4/2/07, "Where Is Microsoft Search?"). And while overall revenue in the unit climbed a modest 11%, to $623 million, hurt by a $37 million decline in the online access business, ad sales grew 23%, to $456 million. Not Google numbers, to be sure.

"They've at least stanched the bleeding," says Sanford C. Bernstein (AB) Senior Research Analyst Charles Di Bona II.

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