Microsoft's Downbeat Outlook

There's little sunshine coming from Microsoft, as it reported its first year-over-year quarterly sales decline and expects a "slow and difficult" recovery

Microsoft CEO Steve Ballmer Kimberly White/Getty Images

By Peter Burrows

There was little optimism in remarks by Microsoft (MSFT) executives when they reported fiscal third-quarter results on Apr. 23. Chipmaker Intel (INTC) had said the PC business had bottomed when it announced earnings on Apr. 14. A few days later, IBM (IBM) gave investors glimmers of hope that the economy may be turning around. And whole divisions of Apple (AAPL) seemed to shrug off the recession entirely when the company's results soundly beat analysts' estimates on Apr. 22.

Microsoft, the world's largest software maker, is seeing no such rays of sunshine. In an Apr. 24 call with Wall Street analysts, Microsoft Chief Financial Officer Chris Liddell sounded downright morose. "We remain more cautious than most," he said. "While we'd all like to hope that the recovery will be short and painless, we unfortunately think it will be slow and difficult."

The numbers show why. In the fiscal third quarter ended Mar. 30, the company suffered the very first year-over-year sales decline in its history, with revenue slipping 6% to $13.65 billion. For starters, Microsoft is feeling the effects of a recession that has depleted demand for PCs. Businesses are hitting the brakes on new computer purchases, and many consumers are opting for new, low-cost netbooks that carry an older version of Windows that costs less than half the amount Microsoft gets for software on a full-featured PC.

Tough Slog in New Markets

Then there are the competitive pressures Microsoft would be facing even if the economy weren't contracting. Apple is siphoning off business in the market for more expensive PCs. And while Microsoft saw brisk sales of its Xbox game console, it's making little headway in other efforts to crack new markets, including smartphones, TV systems, and online search and advertising.

To its credit, Microsoft is taking pains to deal with this new reality. Thanks to the first big layoff in company history, Microsoft managed to match Wall Street's earnings expectations of 39¢ a share, excluding 6¢ in one-time charges related to the layoff and the falling value of some of its equity stakes in other companies. Investors drove Microsoft shares up 3%, to 19.50, reflecting satisfaction with the company's plans to slash an additional $700 million from operating expenses in the quarter ending June 30. This includes cutbacks in bonuses and travel expenditures and the elimination of 1,100 jobs last quarter.

Microsoft CEO Steve Ballmer is also hoping to revive growth with a slew of new products. Jeffries & Co. analyst Katherine Egbert says the next version of Microsoft's operating system, Windows 7, may come relatively soon and possibly in time for the back-to-school shopping season. That might help the company reverse the 15% sales decline in the $15.5-billion-a-year division that includes Windows. Microsoft will also unveil a new version of its Windows Mobile software for smartphones in an effort to keep pace with Apple, Research In Motion (RIMM), and other players in the still-healthy market.

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