Microsoft Posts Gains on Brighter FY03 Outlook

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Despite earlier analyst predictions that Microsoft
might show some of the burn that other software companies have felt the
past year, the company said Tuesday that it exceeded consensus estimates
for its fiscal third quarter and proceeded to slightly boost its guidance for the
full fiscal year.

“We reported another quarter of strong revenue and operating income results
in a very tough environment,” said Microsoft Chief Financial Officer John
Connors. “While there is obviously a great deal of economic uncertainty
ahead, our ongoing investment in R&D has resulted in a broad product
pipeline, including upcoming releases of Windows Server 2003, Visual Studio
.NET 2003, Exchange 2003 and Office 2003. We believe that these innovative
products will enable our customers to get more productivity and value out
of their IT investments.”

The company singled out its Information Worker, Server Platforms and
Business Solutions lines as the driving forces behind its positive results.
It noted that Information Revenue rose 9 percent year-over-year, driven by
demand for Office XP. Looking forward to the forthcoming Office 2003 suite,
the company said initial customer demand for the Beta 2 version of that
product has exceeded demand, and it now plans to issue more than 600,000
copies of the Beta 2 kits. The Office 2003 productivity suite is scheduled
to hit shelves this summer.

Server platforms also showed aggressive growth, according to the company,
with a 21 percent year-over-year increase that Microsoft attributed to
performance across its product line — especially Exchange, SQL Server 2000
and the Windows 2000 family of products. The company said SQL Server
Enterprise Edition lead the pack with revenue growth of 40 percent.
Microsoft said the results reflect Intel-based hardware’s continued share
gains over Unix products in the space.

But the shining line for Microsoft as far as growth is concerned was its
Business Solutions, which posted 96 percent year-over-year growth.
Microsoft attributed the success for the line to the inclusion of revenues
from Navision, which it acquired in July 2002, and added that it has also
been pleased with response to its new Customer Relationship Management
(CRM) product.

“We are pleased with the initial customer and partner enthusiasm for
Microsoft CRM,” said Doug Burgum, president of Microsoft Business
Solutions. “At the end of the quarter, we already had over 1,000 authorized
partners and more than 150 ISVs for Microsoft CRM. Microsoft CRM represents
a key component in our overall mission to deliver transformational
solutions that enable businesses in the midmarket to enhance and deepen the
relationships they have with customers.”

However, Microsoft noted that PC shipments were somewhat weaker than expected, and the current outlook does not look much better.

“There is no clear indication that demand for PCs or corporate IT spin is improving and our expectations aren’t dependent on an improved economic environment,” Connors said.

Overall, Microsoft reported revenue of $7.8 billion for the quarter, an 8
percent increase year-over-year. It also reported net income of $2.79
billion, translating into diluted earnings per share of 26 cents. According
to First Call, which averaged the estimates of 25 analysts, Wall Street was
looking for the company to report EPS of 25 cents. Multex had a consensus estimate of 24 cents per share on revenue of $7.73 billion.

Looking ahead, Microsoft said it expects fourth quarter revenue to fall in
the $7.8 billion to $7.9 billion range, with diluted earnings per share of
23 cents or 24 cents. Connors said the guidance is somewhat lighter than earlier forecasts due to assumptions around MSN subscriptions, a modest decline in assumptions for enterprise spending and the recently-announced cut in the price of its Xbox game console in Europe.

Connors said the company is beginning to see heightened churn with MSN as a result of the expiration of multi-year rebate programs it introduced several years ago.

Still, the company also bumped up its full fiscal year guidance from between 95
cents and 96 cents a share to diluted EPS 97 or 98 cents a share on revenue of about $32 billion.

The company also provided guidance on FY04 which may give investors a slight pause. Microsoft predicted diluted earnings per share will come in at $1.04 to $1.06 for the year on revenue of between $33.1 billion and $33.8 billion. That comes in below the Multex consensus of EPS of $1.08 on revenue of $34.9 billion.

The heightened guidance for FY03 comes on the same day Standard & Poor’s computer
software equity analyst published his latest forecast for the software
industry — a forecast which predicted that the industry’s turnaround is on
hold until late 2003.

“Demand for personal computers remains weak among consumers, and
information technology spending at the corporate level continues to be
constrained,” Jonathan Rudy, CFA, computer software equity analyst and
author of the report said. “As a result, Standard & Poor’s does not
anticipate a return to solid growth in the software industry as a whole
until late in 2003. Aided by the anticipated improvement in the economy,
however, the software market may briefly return to low double-digit growth
at year-end, reaching $200 billion in sales, but this pace will not likely
be sustainable.”

He added, “The software business is increasingly diversifying into the
enterprise market. While corporate software spending will depend on overall
capital budgets and information technology allocation decisions, Standard &
Poor’s believes that key areas of software, such as storage and Internet
security, will likely take share from other areas of the IT budget, even if
overall spending doesn’t recover strongly.”

But Connors said Microsoft is neither counting on an upturn in spending nor a significant decline.

“If demand improves, it should lift all boats,” he said. “If it declines, we would not be immune to the impact.”

However, he added, “There is no doubt we’re in a much better competitive position ending FY03 than we were at the outset of the year. From a macroeconomic standpoint, we’re exiting a difficult year and entering one of uncertainty.”