News > Technology
Microsoft beats the Street
World's largest software firm reports better than expected sales and profits, stock rises.
April 22, 2004: 6:48 PM EDT
By Paul R. La Monica, CNN/Money senior writer

NEW YORK (CNN/Money) - Microsoft reported lower profits for its latest quarter, but the numbers topped Wall Street forecasts, a sign big businesses are finally starting to spend more on personal computers and new software.

Shares surged in after hours trading as investors bet that Microsoft can once again be a relatively high-growth company. Microsoft's good news could also help extend Thursday's big tech stock rally into Friday: shares of other large tech stocks with significant exposure to the PC market, such as Intel (INTC: Research, Estimates), Dell (DELL: Research, Estimates) and Oracle (ORCL: Research, Estimates), all rose more than 1 percent after hours.

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"PC sales are strong and this quarter shows it. And Microsoft still has room for growth in the corporate segment," said Kimberly Caughey, an analyst with Parker/Hunter.

The Redmond, Wash.-based company reported fiscal third quarter net income of $1.32 billion, or 12 cents a share, a decrease of 38 percent from last year's earnings of $2.14 billion, or 20 cents a share.

However, this year's fiscal third quarter results include the cost of Microsoft's restricted stock program for employees and legal charges associated with the company's settlement with Sun Microsystems as well as a fine imposed by the European Commission for antitrust violations.

Backing out those expenses, Microsoft reported earnings of 34 cents a share, well ahead of analysts' estimates of 29 cents a share.

Sales increased 17 percent from a year ago to $9.2 billion. Wall Street had been expecting sales of $8.66 billion, according to First Call.

Mister Softee silences the doubters

Investors seemed to be encouraged by Microsoft's strong third quarter results as well as an upbeat outlook for the fourth quarter. Shares of Microsoft (MSFT: Research, Estimates) gained more than 5 percent in after hours trading according to Island ECN after rising 50 cents, or 2 percent, to $25.95 in regular trading on the Nasdaq Thursday.

The stock has been a weak performer for the past two years, missing out on the tech rally because of concerns about slowing growth in its core business -- selling the Windows operating system and Office software used on most of the world's computers and servers.

Microsoft's next version of Windows, dubbed Longhorn, is not due out until 2006. That has raised worries about whether Microsoft customers will want to buy any new Microsoft software until then.

But in its forecast, the company said it expects sales to be in a range of $8.9 billion to $9 billion for the fourth quarter and that earnings, excluding a 5-cent per share expense for its restricted stock compensation program, would be 28 cents a share. Analysts were predicting sales of $8.88 billion and earnings of 27 cents a share.

If Microsoft's hits the high end of its sales forecast, that would be an 11.5 percent increase in revenues from a year ago.

"Broad-based demand and solid execution across all our businesses drove outstanding results for the quarter," said Microsoft chief financial officer John Connors in a written statement. "Overall corporate IT spending continued to improve and we expect to see healthy demand through the end of our fiscal year."

During a conference call with analysts, Connors added that there has been strong evidence of a corporate recovery taking place in North America, Europe and Japan and that the company expects business PC growth will outpace consumer growth during the fourth quarter of its fiscal year.

In addition, Microsoft reported a smaller than expected decline in unearned revenue, which measures the amount of sales Microsoft expects to record from software license renewals in coming quarters, a key measure of future sales growth. Unearned revenue fell about $325 million from the second quarter, to $7.5 billion.

Investors were spooked in January when Microsoft reported that unearned revenue fell by $395 million in the second quarter and warned that unearned revenue could decline by an even larger amount in the third quarter.

A return to growth?

David Hilal, an analyst with Friedman Billings Ramsey, said Microsoft's results were proof that a corporate upgrade cycle for personal computers and servers has begun, welcome news for the company. "Enterprise spending arguably could be an even bigger boom for Microsoft than consumer spending," Hilal said.

Along those lines, Microsoft reported sharp year-over-year revenue gains in its three largest, and most corporate oriented business segments.

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Sales in its client division, which includes the Windows operating system, increased 16 percent from a year ago. Server and tools sales rose 19 percent and revenue from the information worker segment, which includes Office software, increased 18 percent. All told, these three units accounted for more than 85 percent of Microsoft's total sales.

The company's smaller business segments, such as its MSN online unit and home and entertainment division, which includes the Xbox gaming console, posted strong results as well, with MSN sales rising 16 percent and home and entertainment revenues increasing by 17 percent.

MSN currently accounts for just 6.5 percent of Microsoft's total sales, but Caughey said that MSN should become a bigger part of Microsoft's business since the online advertising market has enjoyed a bit of a renaissance as of late. "MSN looks like an area for growth as well. There are more ads now than in a long long time," Caughey said.

Microsoft also gave its first look at guidance for fiscal 2005.

Its sales outlook was slightly below Wall Street's expectations, with total revenues projected to be between $37.8 billion and $38.2 billion. The consensus estimate among analysts was $38.5 billion.

Connors said the company will face tough sales comparisons in fiscal 2005 due to this year's strong growth in PC and server shipments. He added that Microsoft probably won't benefit as much from favorable currency comparisons next year. The weak dollar has helped lift sales at multinational companies like Microsoft.

But earnings for 2005, excluding stock compensation expenses, should be in a range of $1.31 and $1.33 a share, the company said. That's ahead of analysts' forecast of $1.28 a share.

That news could excite some of the growth investors that had thought Microsoft's best days were behind it. And Microsoft has recently started to intrigue some value-oriented investors as well. The company began paying a dividend last year and doubled it in September.

There has been speculation that Microsoft will raise the dividend again in the near future because the company has been rapidly settling many of its outstanding legal issues. In addition to the Sun settlement and EU fine, Microsoft settled a patent lawsuit with rival InterTrust as well as an antitrust suit with the state of Minnesota earlier this month.

Microsoft had $56.4 billion in cash on its balance sheet at the end of the quarter, up from $52.8 billion as of the end of December. Connors said at a conference in February that the company would give investors a detailed plan about what it intends to do with much of its cash no later than its next analyst meeting in July. Connors reiterated this during Thursday's conference call.

One fund manager that owns the stock said he hopes Microsoft will significantly boost its dividend, which yields just 0.6 percent. He added that despite this quarter's good news, Microsoft still faces slowing growth prospects.

"Microsoft is about as exciting as General Motors in the 50s and 60s," said Henry Hewitt, manager of the Light Revolution fund. "This was a decent quarter but so what?"

Caughey owns shares of Microsoft but her firm has no investment banking ties to the company. Hilal does not own the stock and his firm has no investment banking relationship with Microsoft.  Top of page

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