Microsoft Slightly Higher After Report - TheStreet

Microsoft Slightly Higher After Report

The company raises its revenue and earnings outlook after taking options expensing into account.
Publish date:

Updated from July 17

Shares of tech giant


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were edging slightly higher a day after the company reported fourth-quarter earnings Thursday at the lower end of the company's guidance -- a penny under Wall Street estimates -- on higher-than-expected revenue.

In recent trading Microsoft was up more than 18 cents, or 0.7%, to $26.88.

The software maker raised its outlook for fiscal 2004 revenue and also raised its earnings guidance, when taking into account its decision to expense stock-based compensation. But despite a cash hoard now sitting at a whopping $49 billion, the company said it has no plans to announce another dividend, contrary to rumors.

Microsoft reported fourth-quarter GAAP net income at $1.92 billion, or 18 cents a share, including a $533 million, or 5 cents a share, after-tax charge related to the settlement of the

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lawsuit. A year ago the company reported net income of $1.53 billion, or 14 cents a share, including an after-tax impairment charge of $806 million, or 7 cents a share. The company's guidance called for fourth-quarter earnings ranging from 23 cents to 24 cents a share, while Wall Street estimates compiled by Thomson First Call averaged 24 cents a share.

Microsoft's fourth-quarter revenue was $8.07 billion, an 11.3% increase from the year-earlier period. Microsoft's forecast set fourth-quarter revenue in the range of $7.8 billion to $7.9 billion. Wall Street expected $7.88 billion.

"I would characterize our fourth-quarter results as encouraging," Microsoft CFO John Connors said in a postclose conference call. While the company saw indications of stabilization, he added, IT budgets remain tight.

Guidance Upped

Microsoft changed its earnings guidance for fiscal year 2004 to reflect its recent decision to

expense stock-based compensation, another accounting change involving deferred revenue and a more upbeat outlook. On the call, Connors said Microsoft was supplying slightly higher guidance "due to improved market conditions generally."

The company said 2004 earnings would range from 85 cents a share to 87 cents a share on revenue ranging from $34.2 billion to $34.9 billion. That includes an after-tax stock compensation expense of 24 cents. Without that expense Microsoft's new earnings guidance rises to a range of $1.09 to $1.11, compared to previous guidance of $1.04 to $1.06. Previously, Microsoft forecast 2004 revenue would range from $33.1 billion to $33.8 billion.

The latest consensus estimate, which does not include the stock-based compensation expense, set 2004 earnings at $1.07 on $33.9 billion in revenue.

In addition to deciding to expense stock compensation, Microsoft said it has changed some assumptions about unearned revenue and product life cycles as part of a quarterly review. The upshot is the company will defer a smaller percentage of revenue at the time of sale. As a result, the company will recognize about $400 million in additional revenue in 2004, including $90 million in the first quarter, than previously estimated, the company said.

For the first quarter of fiscal year 2004, which ends in September, Microsoft forecast earnings of 23 cents a share on revenue ranging from $7.9 billion to $8.1 billion. That includes a stock compensation expense of 6 cents a share that was not included in Wall Street estimates, which pegged first-quarter earnings at 25 cents a share on revenue of $7.95 billion. Add back the 6 cents to Microsoft's guidance to compare it to analyst estimates and it looks as if Microsoft's earnings guidance for the first quarter is actually 29 cents, or 4 cents higher than the average Street estimate.

"With Microsoft nothing is quite ever what it seems. I don't want to conclude Microsoft is guiding to 4 cents above consensus because that sounds like a lot," said Tony Ursillo, an analyst with Loomis, Sayles & Co., which owns 3.7 million Microsoft shares.

Still, Ursillo was encouraged by the company's results. "I was pleased to see revenue upside, was initially disappointed that the EPS is a penny shy, but it looks to be primarily from sales and marketing expenses being on the high side." He said he suspected sales and marketing went up -- to $2.1 billion from $1.5 billion last year -- because the company is in the middle of a large product-upgrade cycle.

On the conference call, Connors said part of the explanation was the company's forecast for sales and marketing had been too conservative and some costs expected in the current quarter were incurred earlier. But he said those costs are largely discretionary and implied that they don't signal a long-term jump in sales and marketing expenses.

For the full fiscal year 2003, Microsoft reported net income of $9.99 billion, or 92 cents a share, including after-tax charges for investment impairment of 7 cents a share, charges related to legal settlements of 6 cents a share and a one-time tax benefit of 1 cent a share. That was up from net income of $7.83 billion, or 70 cents a share, a year ago. Revenue in 2003 rose 13% to $32.12 billion from a year earlier.

As of June 30, the company's cash and short-term investments balance climbed to $49 billion, up from $46.2 billion on March 31.

No Extra Dividend

Contrary to rumors that Microsoft might announce a plan to pay more dividends, Connors said the company will not announce any new policy Thursday or at its upcoming analyst day next Thursday. "We are not going to have a dividend program change or a stock buyback commitment to announce at the financial analyst meeting," Connors said. "We really have to get through a couple of very significant legal issues," he said, citing the company's legal battle with

Sun Microsystems

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, an outstanding antitrust review by the European Union and class-action lawsuits. "We don't feel it would be prudent to commit to a long-term program until we see our way through those," he added.

But such caution was not well-received. "I thought that was pretty disappointing," said Standard & Poor's software analyst Jonathan Rudy, who observed some after-hours selling in response to Connors' comments. "The EU is not going to have a $50 billion penalty," he added, noting that some estimates peg the penalty in the range of $2 billion to $3 billion. "It just seems like they are being excessively cautious in this situation." Rudy has a strong buy rating on Microsoft and his firm doesn't do investment banking business.

Overall, he characterized Microsoft's results as solid. "It was a singles, doubles-type of quarter, not a home run," he said. "What you get concerned about is that coming off the


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quarter, people were really expecting the stars, and this is just another solid quarter." Servers were a particular bright spot, he said.

There were signs this week, including Intel's results Tuesday, of an improving PC market, perhaps foreshadowing a better-than-expected top line from Microsoft. On Wednesday, Gartner reported worldwide PC shipments rose 10% to 32.8 million units in the second quarter compared to the year-earlier period. The same day IDC estimated PC shipments of 33.2 million in the second quarter, up 7.6% year over year.

Connor said he expects PC shipments to experience low-single-digit growth in the first quarter. Microsoft saw low- to mid-single-digit percent growth in PC demand in the fourth quarter. That broke down to low- to mid-single-digit growth in North America and EMEA, mid-single to double-digit growth in Asia Pacific, excluding Japan, mid-single-digit declines in Japan and a slight decline in Latin America.

Microsoft's balance of unearned revenue rose $483 million -- more than the $200 million sequential increase projected by the company -- to $9.02 billion. Unearned revenue represents revenue received from customers paying a subscription to use Microsoft's software. Also called deferred revenue by other companies, unearned revenue is first recorded on the balance sheet when a deal is signed and then recognized on the income statement over the period of the contract.

Widespread Growth

Every one of Microsoft's business units recorded year-over-year growth.

Server platforms continued their strong growth, with a 17% increase in revenue compared to a year ago, to $1.93 billion. That was driven by 24% growth in Windows Server revenue and 34% growth in Microsoft SQL server.

Microsoft's Home and Entertainment business, which includes the Xbox video game console, PC games and the TV platform, posted stronger-than-expected results in the fourth quarter. Revenue totaled $483 million, representing 8% growth over the year-ago period on higher-than-forecasted Xbox sales. That's a turnaround from the 42% year-over-year decline suffered by the segment in the previous quarter.

Microsoft said it has sold a total of more than 9.4 million Xbox consoles worldwide and expects to have sold 14.5 million to 16 million consoles by the end of the next fiscal year. However, higher Xbox sales actually reduce margins because Microsoft loses roughly $100 for every Xbox sold.

Microsoft MSN turned in record revenue in the fourth quarter, at $559 million, up 25% from a year ago. That was driven by a 48% increase in advertising revenue.

Revenue from Microsoft's Client segment, which includes its Windows operating system and Tablet PC, rose 4% year over year to $2.53 billion in the fourth quarter.

Revenue from Microsoft's Information Worker segment, which includes Office, climbed 8% year-over-year to $2.35 billion in the fourth quarter.

Microsoft Business Solutions, including Navision and Great Plains software acquisitions, saw an increase in revenue to $179 million in the fourth quarter compared to $86 million in the year-earlier period.