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Microsoft beats, Street says "Sweet"
Solid growth from Xbox and server software and decent guidance impress investors.
January 27, 2005: 6:25 PM EST
By Paul R. La Monica, CNN/Money senior writer
Will strong Q2 results and healthy Q3 guidance propel Microsoft's stock out of its narrow range?
Will strong Q2 results and healthy Q3 guidance propel Microsoft's stock out of its narrow range?

NEW YORK (CNN/Money) - Microsoft reported better-than-expected sales and earnings for the latest quarter Thursday and for once, Wall Street sat up and took notice.

Shares of Microsoft (Research), which have traded in a narrow range the last three years on concerns about slowing growth in its core markets, rose nearly 2 percent in after-hours trading.

"It's very much steady Eddie. Microsoft showed nice growth and better levels of profitability," said David Hilal, an analyst with Friedman Billings Ramsey.

The stronger than anticipated report from the Dow component may help tech stocks and the overall market on Friday. Shares of fellow tech bellwethers IBM (Research), Oracle (Research), Intel (Research) and Dell (Research), for example, were all slightly higher in after-hours trading Thursday.

The world's largest software maker reported that net earnings more than doubled to $3.4 billion, or 32 cents a share, in its fiscal second quarter -- results that topped average estimates by 2 cents a share, excluding stock compensation expenses.

Sales came in at $10.8 billion for the quarter ended Dec. 31, up 7 percent from a year ago, and ahead of consensus forecasts of $10.55 billion.

More importantly, Microsoft didn't disappoint with its guidance for the fiscal third quarter.

The company said it expects earnings to be 27 cents or 28 cents, including compensation expenses for the quarter. Microsoft's compensation expenses typically amount to 3 to 5 cents per share, so excluding these costs, the company's guidance is roughly in-line with Wall Street's consensus forecast of 32 cents a share.

Strong PC sales boost sales

Microsoft also said sales for the quarter would be $9.7 billion to $9.8 billion, slightly higher than the consensus expectation of $9.66 billion. For its full fiscal year, ending in September, the company said sales should be between $39.8 billion and $40 billion, ahead of analysts' projections of $39.3 billion.

In addition, Microsoft reported that its unearned revenue, which measures the amount of sales Microsoft expects to generate from longer-term software licenses, came in at about $8 billion in the quarter, up from $7.8 billion at the end of the first quarter.

Analysts look closely at Microsoft's unearned revenue to gauge whether customers are renewing their licenses with the company. There has been some concern in the past about dips in unearned revenue as customers wait for Microsoft's next version of its Windows operating system, Longhorn, due out in 2006.

But it appears that Wall Street may have underestimated how strong sales of the current version of Windows would be. Sales from Microsoft's client unit, which includes the Windows operating system, rose 5.3 percent to $3.2 billion.

And it makes sense. After all, most personal computers run on Windows and there are indications that PC sales were strong at the end of 2004 and should continue to be fairly healthy in 2005 as well. Michael Dell, chairman of PC market leader Dell, issued a rosy forecast for his company and overall PC growth on Thursday.

"Estimates may have been lower on the Windows side because people were thinking we're in the lull period before Longhorn," said Michael Cohen, director of research with Pacific American Securities. "But strong PC sales will still bring in sales of the older operating system."

To that end, Microsoft corporate controller Scott Di Valerio said during a conference call with analysts, that PC shipments were up 12 percent in the quarter, thanks to strong consumer demand in both mature and emerging markets. Microsoft had previously predicted that PC growth would be between 7 percent and 9 percent.

And outgoing chief financial officer John Connors added that Microsoft now expects PC shipments to be up 9 percent in the third quarter and between 9 percent to 11 percent for the full fiscal year. Microsoft announced earlier this month that Connors will be leaving the company later this year to join a venture capital firm.

Servers and Xbox were scintillating

The increase in unearned revenue and boost to sales guidance may also show that there's more to Microsoft than Windows and Longhorn. Server software sales, for example, were up 18 percent from a year ago.

"The server business did really well. There are good things going on ahead of Longhorn," said Hilal.

Connors jokingly compared the server and tool division's results during the conference call to the playoff performance of the New England Patriots, which are aiming to win their third Super Bowl in four years.

Microsoft's home entertainment business, which includes its Xbox console and software such as its popular Halo 2 video game, also enjoyed a solid quarter. Sales rose 11 percent and the unit posted an operating profit of $84 million, reversing a loss from a year earlier. Microsoft's MSN division also did well, thanks to a booming market for search-based advertising.

So Microsoft's good news could help combat the notion on Wall Street that it is no longer a growth company. But Microsoft is clearly in a difficult spot. It may still have some of the more growthy attributes that investors have come to expect from a tech stock but it has also taken many steps during the past few years that are more common for mature firms.

It began paying a dividend in 2003 and has since increased it several times. Microsoft's yield is now 1.2 percent, lower than the S&P 500, but among the higher yields for tech stocks. And to quell investor backlash about its ever-increasing cash horde, Microsoft paid out a one-time special dividend in December of $3 a share to its investors.

That payout cost Microsoft about $33 billion. As a result, Microsoft's cash balance at the end of December stood at $34.5 billion, a still considerable sum to be sure, but down from $64.5 billion at the end of September.

Analysts quoted in this story do not own shares of Microsoft and their firms do not have investment banking ties to the company.  Top of page

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