Microsoft: PC slowdown, R&D will hurt bottom line

Microsoft says it expects operating costs to increase in some divisions due to continued spending on the development of its Xbox gaming console and .Net initiative.

          After topping Wall Street estimates for the third quarter of its current fiscal year, Microsoft said it expected operating costs to increase in some of its business divisions in the coming quarters due to continued spending on the development of its Xbox gaming console and .Net initiative. Company officials also warned of a further decline in worldwide PC sales.

          Speaking in a conference call Thursday to discuss its earnings for the quarter ended March 31, Microsoft Chief Financial Officer John Connors said the company may see some "margin pressure" from the development of some of its new business initiatives, mainly the Xbox video game console that is set for release later this year.

          "Xbox investments and expenses on .Net development will raise research and development costs a bit," Connors said. "In general, the nature of the game console business is that developing consoles carries significant investments."

          Microsoft also lowered its expectations for the sale of PCs in 2002, which could affect sales of its desktop products. Earlier predictions by Microsoft of a 10% annual increase in PC shipments were reduced to somewhere around 7% or 8%, the company said.

          "Given where the March quarter came out and where the U.S. economy is today, it probably wouldn't be prudent to forecast growth rates higher than we see right now," Connors said.

          Figures from research firm International Data Corporation, which is owned by IDG, the publisher of IDG News Service, show that worldwide PC sales growth fell to 9.5% in the fourth quarter of 2000. [See, "IDC: Weak US consumer PC sales deflate global market," Jan. 22.] Research firm Gartner Group Inc. said in a report released Thursday that worldwide growth rates shrunk again to 3.5% while PC sales in the U.S. have actually declined 3.5%, according to a report in the Wall Street Journal online.

          "We think worldwide PC growth in the March quarter was quite modest, with very weak demand in the U.S.," Connors said. "There are some indications that the PC market could be stabilizing... but we are very mindful of the effect a further slowing economy could have on the industry and Microsoft."

          Revenue for its fiscal fourth quarter, which ends June 30, is expected to be between $6.3 billion and $6.5 billion, Connors said. Earnings per share is expected to come in at $0.41 or $0.42 per share. Microsoft will take a penny charge related to its acquisition of Great Plains Software Inc.

          Analysts had expected revenue of $6.4 billion, but estimated earnings per share of $0.43, according to consensus estimates.

          Still, the company expects to meet its full-year 2002 revenue estimates of $28 billion to $29 billion, as analysts predicted according to First Call/Thomson Financial, although the cost of producing that revenue will increase. Microsoft is also in a good position to meet its revenue goals due to further diversification of its products and traction from strong sales of its .Net server series and Windows 2000 products, both of which will see a number of new product launches in the coming year.

          One of those, Office XP -- which will reach consumers on May 31 -- could be a catalyst for additional growth in its desktop software division, as could the expected debut of the Windows XP operating system.

          Some analysts remain confident that Microsoft's growing line of .Net products will add to sales as it did in the third quarter. The company reported that sales of Windows 2000 products grew 35% compared to the same quarter last year, despite a noticeable slowdown in PC sales.

          Microsoft reported diluted earnings per share of $0.44 on revenue of $6.46 billion, compared to $0.43 per share on revenue of $5.66 billion a year earlier. Operating income was $3.0 billion, up 9.6% on the year-earlier period, while pretax income and net income were 1.2% and 2.8% above year-earlier levels at $3.7 billion and $2.5 billion respectively.

          "What's so remarkable about this past quarter is, clearly we've had slowing in enterprise software and slowing in PC sales, and yet Microsoft still posted a good quarter," said Brendan Barnicle, senior research analyst with Pacific Crest Securities. "Microsoft demonstrated again today that they really are exceptional at executing their business, and I am going to trust their guidance to a fair degree."

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