WSJ on Microsoft with reference to Compaq and PC demand
April 21, 1999
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Microsoft Profit Jumps 43%,
Topping Analyst Expectations
By DAVID BANK
Staff Reporter of THE WALL STREET JOURNAL
Microsoft Corp. escaped the profit squeeze affecting other parts of the computer industry, riding a shift to its higher-priced Windows NT operating system to a 43% gain in earnings for its fiscal third quarter.
Company Profile: Microsoft
The software company reported net income of $1.92 billion, or 35 cents a diluted share, for the quarter ended March 31, compared with $1.34 billion, or 25 cents a share, a year earlier. The company's performance, as usual, beat analysts' consensus estimate of 32 cents a share, according to First Call. Revenue increased 15% to $4.33 billion from $3.77 billion.
After warnings from companies including Compaq Computer Corp. and Intel Corp. about slowing revenue growth due to falling personal computer prices, Microsoft's results were taken as a sign that fundamental demand for PCs remains strong. "I'll take it," said Rick Sherlund, an analyst with Goldman, Sachs & Co. "Things held up pretty well for Microsoft on the PC side."
Greg Maffei, Microsoft's chief financial officer, said, "We are not seeing a meltdown in PC demand." He said unit shipments of PCs are likely to grow by 15% or more this year.
Still Insulated
Microsoft has so far remained relatively insulated from the pricing pressures hitting the rest of the PC industry, but that may not last forever. As consumers increasingly opt for sub-$1,000, and even sub-$500, machines, the licensing fee for the Windows operating system accounts for a higher percentage of a PC's total cost. Mr. Maffei said PC makers are "not reluctant" to raise the issue in negotiations.
Microsoft has no published price list and Mr. Maffei declined to comment on whether Microsoft has accommodated the demands. But analysts said there is no indication the software maker has cut prices. "If you're buying a PC, you don't really have a wide range of choices of operating systems," Mr. Sherlund said. "Everybody's asking, 'As the price of these machines continues to drop, what about the operating system?' The answer is: The price stays the same."
In addition, Microsoft is benefiting from a shift in demand from its Windows 98 operating system, which brings the company about $45 a copy from PC makers, to Windows NT, which is priced at an estimated $85 to $90 a copy. Mr. Maffei said the workstation, or desktop, version of Windows NT now accounts for about 25% of unit sales of Windows PCs industrywide, up from 22% in the previous quarter.
"In a world of sluggish PC-unit demand, to the extent they can make more of them NT machines, they benefit," said David Readerman, a partner at Thomas Weisel Partners, a San Francisco investment bank.
Help From Office 2000
Microsoft released its earnings after the close of stock trading, where its shares rose $2.125 to $83.125 on the Nasdaq Stock Market. In after-hours trading, the stock was quoted at $82.125, according to Instinet.
Microsoft is expected to see a boost in the current quarter from the release of Office 2000, its upgraded suite of desktop applications. The company deferred the recognition of $400 million in Office revenue from the March quarter to future quarters, reflecting the company's obligation to honor coupons entitling recent buyers of Office 97 to free upgrades. In a conference call with analysts, Mr. Maffei said revenue in the current quarter would be about 25% higher than a year earlier, or more than $4.8 billion, with earnings up about 40%.
But that may be a high-water mark for Microsoft, at least for some time. Mr. Maffei said concerns about the year-2000 computer bug are likely to cause some corporate technology buyers to "lock down" their systems for the second half of the year, reducing spending. He said earnings growth in the quarter ending in September would be up only 15% from the year earlier.
Longer term, Microsoft is facing more fundamental challenges. In the market for more powerful "server" computers, the delays in the release of Windows 2000, the next version of the Windows NT operating system, have opened opportunities for Microsoft's competitors, particularly Sun Microsystems Inc. and Novell Inc. Analysts say the growing popularity of the nonproprietary Linux operating system could further damp enthusiasm for Windows 2000.
Jumping to Java
Similarly, many producers of low-cost "appliances" such as handheld computers, set-top boxes and Internet terminals are eschewing Windows in favor of cheaper and less-cumbersome operating systems such as the Java program from Sun. "In set-top boxes, before the year is out, there may be more Java and Linux devices than Windows," said Richard Doherty, a consultant with the Envisioneering Group in Seaford, N.Y.
Even in Microsoft's home turf in PCs, competition is rumbling. Many hardware makers are said to be considering offering "dual boot" machines that enable users to easily switch between Windows and either Linux or the Be operating system from Be Inc., which is targeted at multimedia applications. America Online Inc. is also talking with computer makers about offering a Windows-free machine featuring the AOL service. Mr. Doherty said comments from Microsoft executives about publishing the underlying "source" programming code for Windows could serve as a "green light" to PC makers to consider offering multiple operating systems, because it would be easier to make them work together on one machine if the inner workings of Windows were known.
The extent of competition in the PC industry has been a major issue in the antitrust case against Microsoft currently pending in Washington, D.C. The company has pointed to the growing threats as evidence it doesn't have a lock on the technological future. But Mr. Sherlund of Goldman Sachs points out the gathering trends have yet to dent Microsoft's 91% market share in the PC operating-system market. "Microsoft always seems to find a way to navigate around these obstacles," he said.
As evidence of Microsoft's strength, the company's net profit margin, already the highest of any major company, increased further, to 44%, from 40.2% in the quarter ended December 1998. Microsoft's earnings were bolstered by more than $350 million in realized gains from its $7.5 billion investment portfolio. The company's cash hoard grew to a staggering $21.8 billion, despite the buyback of 10 million shares of stock and an increasing number of cash-equity investments, particularly in telecommunications companies.
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