When tech bellwether
announces fourth-quarter earnings Thursday, the one thing investors will be able to bet on is plenty of confusion.
That's because Microsoft's decision announced last week to expense stock-based compensation likely will require the world's largest software maker to revise its guidance for fiscal year 2004, which began this month. It's largely an accounting issue that doesn't necessarily reflect the health of the company, but analysts still will be paying close attention to how the expense affects Microsoft's numbers because it affects their forecasts.
"You could get some negative knee-jerk reaction on things that are not really operational but more of an accounting issue," said Sanford C. Bernstein analyst Charlie Di Bona, adding that that could represent an opportunity to buy shares. "It will look like guidance came down." Di Bona has an outperform rating on Microsoft and Bernstein doesn't have an investment banking business.
In April, Microsoft said it expects revenue in fiscal year 2004, which ends June 30, to range from $33.1 billion to $33.8 billion, and earnings per share to range from $1.04 to $1.06. For the 12-month period ended March 31, 2003, the latest figures available, expensing stock options would have reduced earnings by 23 cents a share.
So if that expense remains the same in 2004, Microsoft's new earnings guidance for the year could come down to 81 cents to 83 cents a share. That range, however, may be higher because Microsoft has said it plans to hand out less-restricted stock than the company has given out in options.
The current consensus estimate, which does not include the stock-based compensation expense, sets 2004 earnings at $1.07 on $8.54 billion in revenue, according to Thomson First Call.
To avoid confusion over the change in earnings with stock expenses, investors may want to turn to operating income. Microsoft forecast operating income for fiscal year 2004 will range from $14.8 billion to $15.1 billion.
The stock expense issue notwithstanding, some analysts are expecting some upside from Microsoft's fourth-quarter results, in part because PC sales appear to be stronger than the company projected. For the fourth quarter, Microsoft projected earnings to range from 23 cents to 24 cents a share on revenue ranging from $7.8 billion to $7.9 billion. Wall Street estimates are at the high end of that range.
"We think both top line and bottom line will beat expectations," Di Bona said. That will be largely driven by recognition of unearned revenue by Microsoft, he added. 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.
Analysts also will pay close attention to the rise in the unearned revenue line on the balance sheet, which indicates how successful Microsoft is at convincing customers to renew their subscriptions. The company said that the balance of unearned revenue would be up $200 million sequentially from $8.5 billion in the third quarter, but Aziz Hamzaogullari, a senior analyst at Evergreen Investments, said he expects an even larger climb because the June quarter is typically a big one for license agreement renewals.
Good Track Record
Like Di Bona, Hamzaogullari also expects some upside in fourth-quarter earnings and notes that the company beat earnings numbers 12 times out of the last 13 quarters. Evergreen owns 13.9 million Microsoft shares.
Another reason the fourth quarter may be stronger than initially projected: Microsoft is in the midst of a major product-upgrade cycle, with new versions of Windows Server, Visual Studio .NET and SQL Server being released. A new version of Office is slated to debut soon. And finally, judging by
good news Tuesday, PC sales may be stronger than Microsoft anticipated.
"While Intel did not acknowledge a major PC upgrade cycle, it did acknowledge that PCs and IT spending were improving in North America," Pacific Crest analyst Brendan Barnicle wrote in a morning call note Wednesday. "This is a positive for PCs and supports other data points suggesting an uptick in PC sales, all of which is positive for Microsoft." Barnicle has a buy rating on Microsoft, and his firm hasn't done any banking with the company.
Fulcrum Global Partners analyst Jamie Friedman noted that Microsoft's fiscal year 2004 guidance assumed low- to mid-single-digit percentage PC unit growth, while his firm now believes the growth has reached mid- to high-single-digit percentages. "The growth is rising and it's certainly higher than what Microsoft contemplated when they guided," said Friedman, who recently raised his rating on Microsoft from neutral to buy. His firm hasn't done any banking for Microsoft.
However, Microsoft, which some have suggested has seen growth slow as it enters middle age, has been left out of the recent tech rally. Shares of Microsoft have dropped 1.5% in the past three months, while the
has jumped 13.7%.
Older and Richer
The other uncertainty in the company's earnings report may be a dividend, another sign of the company's maturity. With $46 billion in cash and short-term investments in the bank, some say it's time for Microsoft to raise the modest 8-cent (16-cent presplit) dividend declared earlier this year. Standard & Poor's software analyst Jonathan Rudy said he's not expecting any special dividend, as was rumored earlier this month, because he believes it would be contrary to the company's policy of trying to reward long-term stockholders. Rather, he expects Microsoft to raise the dividend, and notes the company easily could afford to triple it.
"If they don't, it will be curious to see why," Rudy said, noting that the company's previous excuse -- longstanding issues -- have largely been resolved. Rudy has a strong buy on Microsoft and his firm doesn't do investment banking.