April 19, 2001 5:25 PM PDT

Microsoft steers clear of PC slowdown

Despite a slump in PC sales, Microsoft managed to slightly exceed profit expectations for its fiscal third quarter.

The software giant earned $2.45 billion, or 44 cents a share, compared with $2.3 billion, or 43 cents a share, a year earlier. A consensus of analysts polled by First Call anticipated 42 cents a share.

Revenue grew 14 percent to $6.46 billion, up from $5.66 billion a year earlier. Analysts had expected sales in the $6.3 billion to $6.4 billion range.

The growth in revenue exceeded expectations, with many analysts reducing projections to the $6 billion range days before Thursday's announcement.

Gartner analyst Chris LeTocq described Microsoft's results as "well-managed expectations."

Microsoft shares, which closed at $68.04 in regular trading, jumped to $72.50 in after-hours trading, according to Island ECN.

Like Intel, which on Tuesday saw an 82 percent year-over-year drop in income, Microsoft's results are closely tied to PC sales. Slow sales throughout the PC industry had been expected to hit the company harder.

Analysts estimate that the bulk of the company's sales and profits come from PC applications and operating systems. Desktop applications such as Office account for more than 50 percent of income.


Gartner analyst David Smith says Microsoft's deep pockets and involvement in businesses other than those focused on desktop products should enable it to withstand the current PC market sluggishness.

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"We are pleased with the March quarter results, which came in on the high end of our expectations," Microsoft Chief Financial Officer John Connors told financial analysts during a Thursday afternoon conference call. But he also expressed reservations about the state of PC growth.

"Business PC growth was actually little better than consumer PC growth, reversing a trend that we have seen over the last several quarters," Connors said. He noted that worldwide PC growth rates are slower than Microsoft had early predicted, now around 7 percent to 8 percent.

Echoing an observation by Intel executives earlier in the week, Connors emphasized, "There are some indications the PC market is stabilizing."

Projections for growth
Analysts had been watching expectantly for Microsoft to give guidance for the remainder of the company's fiscal year, which ends June 30, and the company obliged.

For the fourth fiscal quarter, ending June 30, Microsoft projects sales of $6.3 billion to $6.5 billion and earnings per share between 41 cents and 42 cents. But that is shy of analysts' consensus of 43 cents, according to First Call.

In terms of specific business segments, Microsoft expects desktop application growth in the low single digits and below the current quarter's 7 percent growth.

"In desktop (operating systems), we're looking for growth in the low double digits, as we expect to see continuing momentum for Windows 2000 Professional on the desktop," Connors said. Microsoft expects growth "in the low teens" for business operating systems and services, he added.

Despite continued concern over online advertising, Microsoft expects consumer services, software and device revenue to grow in the upper teens.

For full-year fiscal 2002, Microsoft expects $28 billion to $29 billion in revenue and earnings between $1.90 and $1.94 a share.

Connors spent several minutes prefacing his comments on fiscal 2002, particularly warning about the impact of Microsoft's Xbox video game console.

"You should keep a few things in mind about the business model for gaming," Connors said. "In general, the nature of the console business is that the consoles have a very low or negative gross margin." Connors said that while Xbox would contribute to revenue growth, "We will see some margin pressure from this Xbox entry."

Merrill Lynch analyst Henry Blodget has said Xbox will initially shave 10 cents to 12 cents a share off Microsoft's earnings.

Connors said Microsoft's acquisition of Great Plains Software would contribute to fourth-quarter revenue, but related charges would also shave a penny off earnings. Beyond that, Great Plains should contribute 2 cents per share annually, he said.

Tough quarter
The third quarter gives Microsoft some breathing room after a tough second quarter. Slow PC sales and the cost of rebates for the MSN Internet service contributed to a profit warning for the fiscal second quarter. While the company nudged past reduced second-quarter estimates with earnings of $2.62 billion, or 47 cents a share, desktop application sales disappointed, declining 2 percent year over year to $2.49 billion from $2.53 billion.

That weakness persisted in the third quarter. While desktop revenue grew about 7 percent to $2.4 billion, the majority of sales came from "organizational licenses" in an unexpected spike, Connors said. Microsoft is expected to ship Office XP to its largest licensees later this month. Retailers will begin offering the successor to Office 97 and 2000 at the end of May.

But the sudden sales spike wasn't enough to alleviate an overall trend of slowing desktop application sales, said analysts.

"Those sales are essentially flat for the last year," LeTocq said. "Microsoft has flat revenue growth in a major portion of their business, and they're trying really hard to grow the remaining portion."

He noted that desktop applications, which accounted for about 47 percent of Microsoft's revenue during fiscal 2000, dropped from 40 percent to 36 percent of revenue during the third quarter from a year earlier.

Sales of Windows 2000 continued to show strong gains, despite slow sales throughout the PC industry. Windows 2000 helped buoy desktop operating system sales to $2 billion, from $1.76 billion a year earlier. Server software and services sales also increased, to $1.25 billion from around $1 billion during the year-ago quarter.

Microsoft said Windows 2000 sales grew 40 percent year over year, accounting for 35 percent of Windows sales. Sales of business operating systems and services grew 22 percent, the company said, with sales of SQL Server up about 44 percent.

Original equipment manufacturer (OEM) revenue rose to $1.99 billion from $1.67 billion a year earlier. Microsoft's manufacturer customers sell the company's software bundled with their hardware, such as PCs. Consumer software, services and devices sales rose to $460 million, from $378 million a year earlier.

Internationally, the South Pacific and the Americas accounted for $2.4 billion in sales, up from about $2 billion a year earlier. Revenue for the Europe, Middle East and Africa region was flat year over year at $1.2 billion. Asia saw revenue increase to $836 million from $709 million during the year-ago quarter.

 

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