Microsoft thrills, chills investors

Although Microsoft titillated shareholders with a 2-for-1 stock split and its first-ever dividend, the stock falls in morning trading over the company's reduced 2003 projections.

5 min read
Microsoft's stock split and first-ever dividend weren't enough to overcome Wall Street's apprehension about the software giant's reduced projections for 2003.

The company's shares fell $2.74, or almost 5 percent, to $52.60 in Friday morning trading.

Microsoft did give investors something to cheer about Thursday, with the announcement of the 2-for-1 stock split and dividend. The dividend will be paid out annually at 16 cents a share, on a presplit basis. The split is the ninth since Microsoft went public in 1986. The company expects shareholders to receive their shares around Feb. 14.

But the Redmond, Wash.-based company then also tempered projections for the remainder of fiscal 2003, which ends June 30. Microsoft's trimming back on earnings comes as the company prepares to launch, during the first half of the calendar year, four major products aimed at enterprise customers.

John Connors, Microsoft's chief financial officer, cautioned that the company sees no immediate upturn in technology spending.

In a research note, Merrill Lynch analyst Christopher Shilakes predicted that Microsoft stock "would show a modest pullback this morning," in part because the company "maintained a tempered outlook" for the remainder of the fiscal year.

Typically, Microsoft tends to be cautious about the guidance it issues to Wall Street regarding PC sales and technology spending. "This is not a change from guarded commentary in all quarters of (calendar year) '02," Shilakes wrote.

This time around, Connors warned not only of "tepid" information technology spending growth but also of reduced fiscal 2003 projections. Connors issued the guidance during a Thursday afternoon conference call with financial analysts.

In October, Microsoft projected fiscal 2003 revenue of $33.2 billion to $33.6 billion, operating income of $14.1 billion to $14.4 billion, and earnings per share between $1.89 and $1.95 for fiscal 2003. On Thursday, the company lowered estimates on revenue to between $31.9 billion and $32.1 billion, operating income to between $14.1 billion and $14.3 billion and earnings per share to between $1.90 and $1.93.

For the fiscal third quarter, which ends April 30, Microsoft expects revenue of $7.7 billion to $7.8 billion, operating income of $3.4 billion to $3.5 billion and earnings per share of either 47 cents or 48 cents. For the same quarter a year earlier, Microsoft reported revenue of $7.25 billion and earnings of $2.74 billion, or 49 cents a share.

Analysts noted that Microsoft has good reason to be cautious about technology spending, even as the first hints of a turnaround begin to appear.

"We think IT spending growth (would be) capped at 4 to 5 percent," wrote Brian Skiba, an analyst at Deutsche Bank, in a research note. However, he predicted that growth more likely would be in the 2 percent to 3 percent range, with a "tough first half" of the year. That period of toughest growth would fall during the remainder of Microsoft's fiscal 2003.

Referring to a December survey of North American technology executives, Merrill Lynch's Shilakes reported: "Expectations for a 2004 spending pickup dropped from 18 percent to 14 percent" compared with the results of a September study. The December survey also found that most technology managers believed any uptick in spending would come during the second half of calendar 2003.

"Spending intent showed a dramatic pullback from prior surveys," Shilakes wrote. "Because the survey took place after 2003 IT budgets are largely determined, we place greater credence in the specific forecasts. We believe software vendors will continue to face challenging spending conditions, and remain concerned that the recent stock rally reflects overly aggressive assumptions of a 2003 recovery in IT spending."

During Thursday's conference call, Microsoft's Connors also warned of continued slow growth in PC sales through the remainder of fiscal 2003.

"The company indicated that it has seen no evidence of a change in the health of the PC market," Wachovia Securities analyst Jason Maynard wrote in a research note.

On the horizon
On Thursday, market analysts Gartner Dataquest and IDC reported a slight rebound in PC shipments, both for the fourth quarter and for the year. This follows a devastating 2001, when PC shipments declined for the first time in more than a decade and a half.

But like Microsoft, Intel this week cautioned Wall Street that the rebound in technology spending had yet to occur. Andy Bryant, Intel's CFO, warned during a conference call with analysts this week that "everything's been happening the way it should. The question is: When does the market return?"

In a research note, Merrill Lynch analyst Steven Milunovich predicted that during the first quarter, "Our estimates call for worldwide units to decline 9 percent sequentially and grow 5 percent year-over-year. This forecast is roughly similar to the views from Microsoft and Intel."

In other circumstances, Microsoft might have more reason for optimism, as the company prepares to launch major new products that target larger enterprise customers that it hopes will jumpstart its .Net Web services initiative.

On tap are Windows 2003 Server, Exchange Server 2003, Office 11 and a new suite of server products code-named Jupiter.

"Historically (Microsoft) has spiked with new releases of Windows and Office," Brendan Barnicle, an analyst at Pacific Crest Securities, wrote in a Wednesday research note.

Windows 2003 Server, which is scheduled to debut in April, is important as the product will anchor .Net. Exchange Server 2003 and Office 11 are scheduled for midyear release. Jupiter could appear around the same time. All four products target enterprise customers, but takeup of some of the software could be tempered by the continued slowdown in technology spending.

Still, there is some good news for Microsoft in the long term. "About two-thirds of our respondents indicate they will procure more software under a subscription license model in the next three years," Shilakes said, referring to a recent technology executive survey.

On Aug. 1, Microsoft fully enacted its Licensing 6, under which customers pay for software in annual payments during two- or three-year contracts. Microsoft initially records the money as unearned revenue, turning it into actual revenue over the life of the contract. Realization of unearned revenue accounted for 22 percent of Microsoft's revenue in the fiscal second quarter that just ended, and 23 percent in the previous quarter.

Microsoft ended its second quarter with $8.83 billion in unearned revenue. During its first quarter, unearned revenue swelled to $9.13 billion, mostly from licensing, up from $5.85 billion a year earlier.

As more customers shift to an annuity-based model of payment, Microsoft will be able to smooth out the highs and lows in its balance sheet, say analysts. The company would be less subject to seeing huge sales immediately after the release of a new product, followed by a sharp decline in sales later in the software's lifecycle.