Microsoft Carries Tech Banner

The company's upbeat outlook has helped ease Nasdaq jitters.
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didn't hit a home run in the third quarter -- revenue was light -- but its substantial profit and bullish guidance for the next quarter and the next fiscal year were a good anecdote to the jitters that have roiled the technology sector during the earnings season.

Reaction on Wall Street was in line with the mixed performance: in recent trading on Friday, shares of the software giant were up 43 cents, or 1.8%, to $24.88 on unremarkable trading volume.

Microsoft, of course, is widely seen as a technology bellwether, so the company's view that "spending

on technology was healthy in the quarter and will remain healthy," helped dampen the effect of the University of Michigan consumer confidence report showing a larger-than-expected drop in consumer outlook on the economy.

The company said PC unit sales grew a bit more than expected in the third quarter (10% vs. 9%) and will grow by 9% to 11% growth during the balance of the fiscal year ending June 30. As expected, the company projects that PC sales will slow somewhat in fiscal 2006, as customers wait for a new version of Windows to ship before they buy new systems. Growth of server sales should be flat with this year, the company said, without attaching specific numbers to either forecast.

Deferred revenue, a measure of ongoing contract renewals, shrank by just $25 million in the quarter, far less than analysts had expected. Rich Sherlund of Goldman Sachs, for example, projected a decline of $300 million in the seasonally slow March quarter. He noted that there is $2.5 billion of license business up for renewal in the June quarter and an expectation that deferred revenue could be up $800 million to $900 sequentially in the quarter. Goldman Sachs has an investment banking relationship with Microsoft.

Although the revenue miss was somewhat disappointing -- $9.62 billion, or 5% growth, vs. expectations of $9.8 billion -- the company now says sales will accelerate by 9% in the fourth quarter and 9% to 11% in fiscal 2006.

It's worth noting that about 40% to 60% of the revenue miss in March was the result of a decline in the value of the euro off its January highs. Currency effects added about $188 million to revenue growth, compared with $250 million in the previous quarter, said Sanford Bernstein analyst Charles Di Bona, whose firm does not have a banking relationship with Microsoft.

GAAP earnings were strong, nearly doubling to $2.56 billion, or 23 cents a share, compared to last year's charge-laden results of $1.3 billion, or 12 cents a diluted share.

Nearly every analyst who published a note following the announcement focused heavily on the expected blitz of major new products expected from Microsoft in the next 18 months or so.

First up is the launch of Xbox2, scheduled to be unveiled in May and shipped in the fall, followed by new versions of the company's SQL Server database and development tools. And in late calendar 2006, Longhorn, the new version of the company's flagship Windows operating system and a new version of Office, will arrive.

The importance of Longhorn and Office are difficult to overestimate; the two products accounted for 60% of Microsoft's revenue in the March quarter. It is not yet clear

if Longhorn will be the big hit the company needs to break out of its narrow trading range, although the sentiment on Wall Street seems to favor it.

Commented Di Bona: "We believe that the mid-year planned beta of the long-awaited Longhorn OS may serve as a catalyst for Microsoft's stock. With this real tangible evidence that Longhorn is indeed on the horizon, we suspect that investors may begin to focus on the potential upside to Longhorn, which we estimate to be substantial, rather than on the delays in its launch."

For the fourth quarter, the company expects revenue to range from $10.1 billion to $10.2 billion, roughly in line with analysts polled by Thomson First Call. On a GAAP basis, earnings will be about 27 cents or 28 cents a share. Wall Street was expecting 27 cents on the same basis.

For the full year ending June 30, 2006, revenue is expected to be in the range of $43.3 billion to $44.1 billion, and diluted earnings per share are expected to be between $1.26 and $1.30, including stock-based compensation expense. Wall Street was expecting $40 billion in revenue and EPS of $1.26.

Microsoft repurchased 95 million shares worth $2.42 billion in the March quarter. Although the size of the buyback is not indicated in guidance, Di Bona believes future purchases will be significant enough to add to earnings per share.