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Microsoft beats earnings expectations, but sales slow

The PC industry bellwether beats Wall Street expectations, but the results are tempered by news that sales of corporate PCs were slow.

Microsoft today beat Wall Street expectations, reporting earnings of 43 cents per share for its third quarter, but the results were tempered by news that sales of corporate PCs were slow.

The software giant and PC industry bellwether reported earnings of 43 cents, or $2.3 billion, on revenues of $5.66 billion. This is up 23 percent compared with the same period last year, when Microsoft reported 35 cents per share and $4.6 billion in revenue.

The consensus of analysts polled by First Call expected the software maker to report earnings of 41 cents per share for its third fiscal quarter. The "whisper number," an unofficial, informal estimate, was 45 cents per share.

The company's third quarter was marked by enthusiastic response to the release of Windows 2000, tempered by slow sales of business PCs and related products, it said.

Microsoft confirmed analyst speculation that sales to the corporate sector are slowing, with chief financial officer John Connors noting that demand for corporate PCs has "remained slow in the quarter." Microsoft's most profitable products, notably Windows 2000, are targeted at the corporate market.

Slow corporate buying hit the Windows Group hardest, Connors said. "Demand didn't pick up until the last few weeks of the quarter," he said in a conference call with analysts. "It improved late in the quarter and should improve for the fourth quarter. PC shipments were strong, but not strong enough to offset it."

Microsoft has shipped 1.5 million copies of Windows 2000 since the operating system's February launch and has signed on customers such as General Motors, Wells Fargo and Siemens, the company said.

So far, Microsoft's stock has dropped in after-hours trading. The stock is trading around $76.25 after closing at $78.94. Intel and other high-tech companies have seen their stock prices dip in the past two weeks after beating official earnings estimates but coming in below the whisper numbers.

Long-term growth is likely to be in the mid-teens, as Microsoft's product franchises become more mature, Connors cautioned.

"Getting multi-digit growth out of these franchises, and with the number of shares outstanding, it's tough," he said, explaining that next quarter will also see relatively conservative growth compared with the previous quarter, which benefited from one-time revenues associated with the redemption of Office 2000 coupons. "It's a bit of a transition quarter."

Microsoft's stock has been pummeled by investors in recent weeks because of fears about the future. A resolution of the antitrust case, which could significantly affect the company's prospects, is expected soon.

Today in Washington, D.C., a class-action lawsuit was filed against Microsoft on behalf of all Windows 98 buyers, alleging that Microsoft's illegal actions as a monopoly harmed all consumers. Many analysts have predicted a flood of these types of lawsuits in the wake of the antitrust verdict.

Some analysts also have said that corporate PC sales have been slow in the past few months, which could reduce demand for Microsoft's Windows operating system. PC and chip manufacturers, however, have reported that demand for PCs this year has been stronger than expected.

Although the third quarter saw two of the most significant events in Microsoft's history--the landmark antitrust verdict against the company and the launch of Windows 2000--neither event had much effect on this quarter's bottom line.

By product group, Microsoft reported revenues of $2.3 billion for its Windows Group, compared with $2 billion for last year's quarter. Revenues were $2.59 billion in the Productivity Applications Group, which is responsible for Office 2000, compared with $1.96 billion for the previous quarter. And the Consumer Group reported sales of $756 million, compared with $598 million last year.

The slow growth in Windows revenues reflects slower corporate PC sales, Microsoft said, as the company earns revenues for each PC sold with its operating system pre-loaded. The consumer division, which includes MSN and entertainment software, was up 26 percent in revenue, but it was hurt by the company's low-price Internet access promotions.

By region, sales to the South Pacific and South America were up 32 percent Microsoft's ups and downs to $2 billion; sales to Europe, the Middle East and Africa were up $28 percent to $1.26 billion; and sales to Asia were up 44 percent to $709 million, the company said. Revenues were hurt by negative foreign exchange rates.

Microsoft operating costs came down from 15.4 percent in the third quarter of 1999 to 13.3 percent. The company attributed the drop to lower costs associated with WebTV, Microsoft's struggling TV-Internet service division, which has had problems filling open job positions.

Investment income rose $885 million from $720 million, an area that many analysts have said is key to watch. "Microsoft has a huge investment portfolio--Lernout & Hauspie is up 100 percent alone," said Frederic Dickson, an analyst with Branch Cabell. He added that other companies, such as Intel, also hold stakes in numerous companies, which can have an unpredictable effect on quarterly earnings.

"We think shareholders should feel good that we're making gains on investments," Connors said, adding that Microsoft's 64 investments represent $2.7 billion and cover a broad spectrum of companies.

Microsoft earnings are an important indicator of the health of the PC market, as the company's numbers reflect the strength of both corporate and consumer computer sales. Analysts say that this quarter, the company's performance will receive particularly close attention, given the volatility of the markets.

Earlier this month, for example, the company's stock took a hit after Goldman Sachs trimmed its third-quarter revenue outlook to $5.75 billion from $5.95 billion, citing slowing demand for personal computers, despite the fact that analyst Richard Sherlund did not change his earnings estimate.

"We usually don't worry so much about earnings releases from Microsoft; they have a history of coming through with the numbers," said Robert Becker, an analyst with Argus Research, whose expectations were in line with the consensus 41 cents per share. "If they did have a negative surprise, it would have a significant negative impact on technology shares."

Although the stock markets pitched radically earlier this month, several PC and hardware makers already have reported better-than-expected numbers and earnings growth above 35 percent for the first calendar quarter. Demand, according to many of these companies, has been stronger than expected.

Investors have had mixed reactions to earnings results. Intel, for instance, beat analysts' expectations, excluding nonrecurring events, of 71 cents a share. However, the company said that it underestimated demand and that chips would be in tight supply through the first half of the year.

As a result, the stock dropped instead of rising after the earnings announcement. Other companies that beat results also saw similar counterintuitive stock moves.