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Windows of opportunity?
Microsoft posts a mixed 3Q but strong sales guidance lifts stock after hours
April 28, 2005: 6:16 PM EDT
By Paul R. La Monica, CNN/Money senior writer
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NEW YORK (CNN/Money) - Microsoft, the world's largest software company, reported mixed fiscal third quarter results Thursday...but a promising outlook that pleased Wall Street.

Sales for the quarter that ended in March came in at $9.6 billion, about $200 million below Wall Street's consensus estimates. But net income and earnings, excluding the effect of a legal charge and expenses for stock compensation, met Wall Street's targets.

More importantly though, Microsoft issued sales guidance for its fiscal fourth quarter that was ahead of expectations. The company said that revenues for the fourth quarter, which ends in June, would be between $10.1 billion and $10.2 billion, slightly ahead of the consensus estimate of $10.07 billion.

Microsoft also made its first public comments about what it expects to see in fiscal 2006, saying that sales should be in a range of $43.3 billion to $44.1 billion. The $43.7 billion midpoint is above Wall Street's $43.4 billion estimate. If Microsoft hits this target, sales would be up nearly 10 percent from fiscal 2005 levels.

"For a company of Microsoft's size, this is good revenue growth. It shows that there is life here," said Alan Davis, an analyst with McAdams Wright Ragen.

In addition, Microsoft's closely watched unearned revenue number, which reflects sales expected to be generated in the coming quarters from license renewals, was essentially unchanged from the end of the second quarter.

Unearned revenue was $7.94 billion as of the end of March, a slight dip from $8 billion at the end of December. That's an encouraging sign as some analysts were expecting unearned revenue to fall more than $300 million from the end of Microsoft's second quarter.

Taking the bulls by the Longhorn

Investors appeared to like the news as well. Shares of Microsoft (Research), a Dow component, rallied about 1 percent after-hours according to INET following a 2.2 percent dip in regular trading on the Nasdaq Thursday. The stock has slipped more than 8 percent this year and has been stuck in a tight range for the past three years.

The company has failed to excite many investors for the past few years due to a lack of major new products. Many on Wall Street believed that Microsoft would not see a major pickup in demand until the end of calendar 2006 (which is the beginning of Microsoft's fiscal 2007) since that is when Microsoft is due to finally release the eagerly awaited update of Windows, dubbed Longhorn.

But this notion is starting to change as the company is set to unveil a sequel to its popular Xbox video game console, its latest database software for corporations and an new version of its Windows operating system for 64-bit computers in the coming months.

"This is now a period with a lot of anticipation for new products. Only six months ago people were quite convinced that calendar 2005 would be a dead year as we waited for Longhorn but it's going to be more dynamic than that," said Mark Stahlman, an analyst with Caris & Co.

Slowdown? What slowdown?

Microsoft reported particularly strong gains in its server software business, which accounts for a quarter of the company's total revenues, and its home entertainment division, which includes Xbox hardware and software.

Server software sales increased 11.5 percent from a year ago while home entertainment revenues were up 12 percent.

"On the whole this is modestly positive news," said Richard Williams, an analyst with Garban Institutional Equities, adding that the company should continue to see momentum in its home entertainment and server software units.

Microsoft's more PC-focused divisions, Client (which includes the Windows operating systems) and Information Worker (which includes the Office suite of tools such as Word and Excel), posted slower levels of growth.

But during a conference call with analysts, Microsoft's corporate controller, Scott DiValerio, said that the company saw slightly stronger than expected growth in the PC industry. DiValerio added that corporate demand for PCs was stronger than consumer demand and that it should remain healthy despite some uncertainties about global economic growth.

To that end, Microsoft's solid guidance and comments about corporate demand would appear to be another sign that some of the concerns about a slowdown in tech spending may have been overdone. Investors feared that techs would be in for a rough few months after IBM (Research) reported weak first quarter results two weeks ago and said that it saw a sudden drop in global demand in March.

But since then, there have been favorable earnings reports from other tech bellwethers, such as Intel (Research) and Texas Instruments (Research). And a report from tech research firm Gartner showed that personal computer leaders Dell (Research) and Hewlett-Packard (Research) enjoyed decent gains in PC shipments during the first quarter.

"This is an important signal for not just Microsoft but others in tech," said Stahlman.

Analysts quoted in this story do not own shares of Microsoft and their firms have no investment banking relationships with the company.

For a look at more tech blue chip stocks, click here.

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