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The 'softer' side of tech
Earnings growth for software in 3Q is expected to be rather tame. Will 4Q be any better?
September 10, 2003: 5:24 PM EDT
By Paul R. La Monica, CNN/Money Senior Writer

NEW YORK (CNN/Money) - Tech companies are expected to shine once third-quarter earnings season kicks into high gear next month. But not all tech companies will be reporting robust growth.

Overall, software stocks are expected to post only a 6 percent earnings gain in the quarter, according to First Call. That's much lower than the forecast of 78 percent for the overall tech sector.

"This is traditionally a weak quarter but software right now has just flat-lined. Expectations are pretty low," said Richard Williams, strategist for Summit Analytic Partners, a research firm that focuses on software.

Design software developer software firm Adobe Systems (ADBE: Research, Estimates) was the first major software company to report its latest numbers, with its fiscal third-quarter earnings due out after the bell Wednesday. The company reported pro-forma earnings per share of 28 cents, three cents better than analysts' expectations and an increase of 26 percent from a year ago.

Oracle (ORCL: Research, Estimates) will report its fiscal first quarter results Friday morning, with estimates of a 14 percent increase in earnings from the same period last year. But those growth rates are among the best for large software firms.

Looking at some of the companies that report next month, Siebel Systems (SEBL: Research, Estimates) is expected to post no earnings growth, while Microsoft (MSFT: Research, Estimates) and SAP (SAP: Research, Estimates) have estimated growth rates of 5 percent and 6 percent, respectively.

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Software sales and earnings typically lag during tech recoveries. Chips and hardware usually need to bounce back first before demand for new software kicks in. Once corporations are comfortable enough to splurge on new computers and servers, then they will upgrade software licenses as well.

"Usually, business spending on software doesn't happen at the beginning of a recovery but once the recovery is undeniable," said Michael Cohen, director of research for Pacific American Securities.

Pickup in fourth-quarter demand?

However, the relatively sluggish forecast for the group has not stopped many software stocks from rallying. Shares of Microsoft are up nearly 10 percent in the past month while Oracle and SAP have each gained more than 15 percent.

It appears that investors are willing to overlook the relatively weak third-quarter outlook in the hopes that the fourth quarter will be much stronger.

Computer Software
Technology earnings
Written by: Paul R. La Monica

But that's a risky bet. Brian Foote, an analyst with Ryan Beck, said that the recent pickup in demand for chips and hardware appears to be driven more by the normal back-to-school shopping season in the third quarter.

That means that if anything, more consumer oriented software companies could benefit in the fourth quarter, not so-called enterprise software companies that develop applications for businesses. "The back to school phenomenon does not help the enterprise software group," Foote said.

And Williams is worried that the apparent demand for hardware may not be sustainable, which could cause an inventory overhang heading into 2004.

"The bet that computer vendors are making as they build up inventory is that fourth quarter sales will see a big surge. If we don't get that it will be trouble for software," Williams said. "Everything comes down to the fourth quarter."

Pacific American's Cohen owns shares of Microsoft but his firm has no investment banking relationship with it or other software companies. Other analysts quoted in this piece do not owns stocks mentioned and their firms have no investment banking relationships with them.  Top of page

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