Earnings Show Microsoft Needs Yahoo

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Liddell said he's reluctant to offer more for Yahoo: "The strongest argument that we should increase our bid—simply because we can afford to—is not one that I favor." But the protracted takeover battle hasn't helped Microsoft's share price. A 30% second-quarter sales increase (BusinessWeek.com, 1/25/08) that Microsoft reported on Jan. 24 cheered investors. Since then, Microsoft shares have fallen by 4.4%, compared with a 2.7% gain for the Standard & Poor's 500-stock index.

Meanwhile, other tech-sector bellwethers have turned in upbeat reports and forecasts. Intel (INTC) shares have rallied 8.5% since Apr. 15, when the world's largest chipmaker issued a positive revenue forecast for the second quarter and predicted healthy profit margins for the year. Shares of IBM (IBM) are 3% higher after the computer concern beat expectations for first-quarter profits on Apr. 16 and raised its 2008 earnings forecast. And Apple (AAPL) shares gained 4% on Apr. 24 after the company reported a 36% increase in second-quarter profits (BusinessWeek.com, 4/24/08).

Vexing Vista Sales

Microsoft's results were hurt by slower sales of Windows Vista, introduced a little more than a year ago. Revenue in Microsoft's client division fell 24% during the quarter, to $4.03 billion. Even after accounting for the effect of the coupons last year, client revenue fell 2%. Microsoft's Chief Accounting Officer Frank Brod says the product suffered from a tough comparison to the March quarter of last year, when it launched Windows Vista. But many consumers and businesses have continued buying the older Windows XP system, and Ballmer has hinted he might extend sales past a proposed June 30 cutoff date.

The weakness in Vista sales was especially vexing given the overall strength of the PC market, analysts said. Market researcher IDC recently reported worldwide PC sales rose a stronger than usual 14.6% in the first quarter. Getting Vista and its Office 2007 suite onto as many of those machines as possible will be an engine of growth in coming quarters, and Microsoft's Brod says the sales dip was temporary.

Indeed, the 2009 fiscal year that starts on July 1 looks stronger. Microsoft said it expects $66.9 billion to $68 billion in sales, and earnings of $2.13 to $2.19 per share for the year. Analysts had expected a forecast of $66.47 billion in sales and earnings of $2.11 per share in 2009.

Compelled to Reach an Agreement?

Still, Microsoft remains weak in key areas. The online services division continues to bleed red ink. The group, which sells ads associated with Web searches and other online software, widened its loss to $228 million, compared with $171 million a year ago, though revenues grew 40%, to $843 million. Yahoo reported first-quarter sales on Apr. 22 of $1.35 billion that slightly beat Wall Street's expectations (BusinessWeek.com, 4/23/08).

Ballmer said Yahoo's results won't cause Microsoft to raise its offer. Yet the two companies may be compelled to hammer out an agreement soon. Microsoft is feeling the pressure from investors—UBS (UBS) analyst Heather Bellini wrote in an Apr. 17 research note that completing the deal is key to capturing a chunk of future online advertising revenue from Google. She noted: "Microsoft must get this acquisition right to remain relevant in the Internet age."

Ricadela is a writer for BusinessWeek.com in Silicon Valley.