Microsoft's Earnings Don't Disappoint

The software behemoth's fiscal first-quarter numbers provided investors with some reassurance that the floor isn't falling out from under global IT spending

As they waited for Microsoft's Oct. 23 quarterly earnings call to begin, analysts and others were treated to a rousing rendition of the theme from The Lone Ranger. Nostalgia for the heroic masked avenger might seem ill-suited to these dour economic times. And yet while the software giant didn't exactly come to the rescue of worried investors, its results left many feeling reassured.

As other tech bellwethers have done, Microsoft has cut its forecasts and is having difficulty predicting the future. Still, the company's fiscal first-quarter numbers show the floor is not falling out from under global IT spending. Microsoft (MSFT) not only beat analysts' revenue and profit expectations in the period that ended in September, but its forecast for this quarter is based on an assumption that the recession will be mild.

Redmond (Wash.)-based Microsoft expects PC sales to grow a respectable 10% to 12% this yearend shopping season. "It's important to keep things in perspective," Chief Financial Officer Chris Liddell told analysts who asked for details on the depths of the slowdown. "We still see revenue growth."

Office Sales Remain Strong

First-quarter sales grew 9%, to $15.06 billion, beating analysts' expectations for $14.8 billion. Profit rose 2%, to $4.37 billion. Liddell said conditions "clearly deteriorated" as the credit crisis worsened in September, but didn't say by how much. Still, sales of server software used by corporations grew 18%, and sales of the Office productivity program remained brisk as well.

Microsoft showed surprising strength in its consumer-products division. While sales fell from last year, when the company benefited from blockbuster sales of the Halo 3 game for its Xbox console, sales exceeded Microsoft's expectations and profit rose to $178 million, from $167 million. Even Microsoft's beleaguered Internet business had good news. While losses nearly doubled, to $480 million, sales grew a respectable 15% despite a difficult online ad market.

Underscoring the difficulty of assessing a weakening spending environment, Liddell gave a wide range of forecasts for the first half of 2009. But even that range is more optimistic than might be expected. For example, Microsoft's worst-case scenario calls for sales of $64.9 billion in fiscal 2009. That's 2.55% short of analysts' consensus expectations for the year. Apple (AAPL), which has a reputation for setting low financial targets that it almost always beats, indicated on Oct. 21 that sales in the current quarter could fall 14% below consensus estimates. Networking equipment maker Juniper Networks (JNPR) said two days later that current-quarter sales might fall to $921 million, 4.7% below analysts' estimates.

Emerging Markets Are a Wild Card

Even if the country suffers from what Liddell described as a "deep recession," Microsoft will grow 7% for its fiscal year, compared with 18.2% for the year that ended in June. If the company's more positive forecast pans out, Microsoft will grow 10%. Liddell expects overall tech spending to stay in the black as well.

One wild card is emerging markets. Russia was the company's fastest-growing market for PCs in the past year. Liddell told BusinessWeek that while the market will slow, it will still grow at a double-digit pace. But turmoil in fast-growing countries is particularly hard to forecast. "It's a real threat that emerging markets will slow down in 2009," says Technology Business Research's Allan Krans.

As upbeat as Microsoft's predictions were, the company is taking precautions just in case. It plans to cut $500 million in operating expenses, partly by slowing hiring and trimming travel expenses. The company also will slow spending on construction of new data centers, server-packed facilities that handle Microsoft's own needs as well as the so-called cloud computing demands of outside customers.

Plenty of Cash on Hand

"It's a surprising thing to do, since they say they're betting the future on cloud computing," Krans says. At a technical conference for its software partners starting Oct. 27, Microsoft is expected to make a host of announcements about its plans to meld typical corporate IT operations with online services that will be doled out from Microsoft's own data centers.

If Microsoft comes across as confident, it's probably because the company can afford to be. It's got $20.7 billion in cash in the bank, and a business model based in large part on multiyear software licenses. That makes for much steadier revenue growth than relying on product sales.

Burrows is a senior writer for BusinessWeek, based in Silicon Valley .

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