Microsoft's X-rated results
Despite lower than expected Xbox 360 sales, earnings hit targets; stock up after-hours on guidance.
By Paul R. La Monica, senior writer

NEW YORK ( - X didn't mark the spot for Microsoft but Wall Street didn't appear to mind.

Microsoft, the world's largest software company, reported fiscal second-quarter sales of $11.84 billion, up 9 percent from a year ago but below Wall Street expectations of $11.96 billion in revenue for the quarter that ended in December.

Range-bound: Microsoft's stock hasn't done much for the past few years. But is it ready to break out thanks to optimism about new products?
Range-bound: Microsoft's stock hasn't done much for the past few years. But is it ready to break out thanks to optimism about new products?
Microsoft couldn't produce enough Xbox 360 game consoles to meet demand during the holidays and that hurt overall sales for the second quarter.
Microsoft couldn't produce enough Xbox 360 game consoles to meet demand during the holidays and that hurt overall sales for the second quarter.

Analysts said weaker than expected sales of the company's new Xbox 360 game console, which came out last November, was the biggest reason for the miss as the company was unable to produce enough consoles for the holiday shopping rush.

"Demand was good for the Xbox 360 but the company had supply chain constraints," said Jamie Friedman, an analyst with Soleil -- Fulcrum, an independent research firm.

During a conference call with analysts, Scott Di Valerio, Microsoft's corporate vice president of finance and administration and chief accounting officer, said that Microsoft felt the Xbox 360-related component shortages were just a temporary problem and that the company had taken steps to increase supply going forward.

Microsoft's earnings, which came in at 34 cents a share for the quarter, were up 5 percent from the same period in 2004. Excluding a penny per share tax benefit, earnings met Wall Street's expectations of 33 cents a share.

What's more, the company issued upbeat guidance for its fiscal third quarter, saying that sales should be in a range of $10.9 billion to $11.2 billion. The $11.05 billion midpoint of this range is slightly higher than Wall Street's consensus estimate of $10.99 billion.

The company also said it expected earnings per share to be 32 cents or 33 cents for the quarter. Analysts had been forecasting a profit of 33 cents per share.

In a written statement, Microsoft cited robust sales of software to large corporations. Sales in the company's servers and tools business increased 14 percent from a year ago, while Microsoft's Information Worker (Office products like Word and Excel) and Client (Windows operating system) divisions saw sales increases of 5 percent and 8 percent respectively. These three divisions, combined, account for nearly 80 percent of Microsoft's total sales.

"Demand for our desktop and server products from enterprise customers was particularly strong this quarter with significant sales and customer momentum from our recently launched server products," said Kevin Turner, chief operating officer at Microsoft, in a statement.

During the conference call, Microsoft's chief financial officer Chris Liddell said that the company was pleased with consumer personal computer sales during the holidays as well. He added that Microsoft now expects PC shipments to increase between 11 percent and 13 percent for the third quarter and that shipments would be up 12 percent to 14 percent for the full year.

Shares of Microsoft (Research), which finished slightly higher in regular trading on the Nasdaq Thursday, shot up nearly 2.5 percent in after-hours trading. The stock has been stuck in a narrow range for the past four years due to concerns about sluggish sales and earnings prospects and increased competition from new rivals such as Google. (Research)

But Microsoft, which in addition to Xbox 360, recently released its new SQL Server 2005 database software, is expected to see a pickup in growth thanks to these new products as well as the upcoming release of Microsoft's long-awaited new operating system, known as Vista, and the latest version of Office: Office 12.

"I'm excited about the second half of the year," said Michael Cohen, director of research with Pacific American Securities. "That's when we'll likely see Vista and Office 12, some of the most significant releases in the company's history. I think that will lead to a PC upgrade cycle in the second half of the year."

To that end, Microsoft reported that its unearned revenue, which measures sales the company expects to record in coming quarters from longer-term software licenses and is therefore a key barometer of future revenue, of $8.84 billion, a slight increase from the unearned revenue it reported at the end of the first quarter. Analysts cheered the fact that this figure increased from the end of September.

"Unearned revenue is more important than sales or earnings. And we expected unearned revenue to rise sequentially," said Friedman.

Richard Williams, an analyst with ICAP, added that he didn't expect new products to contribute a whole lot to sales in the immediate future but that the pickup in unearned revenue was a plus.

"Unearned revenue matters, especially for the long-term so an increase would help," Williams said.

Results were mixed in the rest of Microsoft's businesses, however. The company's home and entertainment business, which includes Xbox, reported a loss. Sales and profits in Microsoft's MSN Internet unit dipped from a year ago. MSN is set to launch a new online search tool for advertisers soon called adCenter but many analysts think the company will continue to face an uphill battle competing against Google and Yahoo! (Research) Liddell said that MSN revenues would likely be flat for the full fiscal year.

But Microsoft's small mobile and embedded devices software division reported a 40 percent jump in sales and an operating profit of $20 million, reversing a year ago loss. Microsoft's business solutions unit also posted a small profit after losing money a year ago, thanks to a 17 percent increase in revenue. Liddell said during the call though that these divisions probably would not be profitable for all of fiscal 2006.

For the full fiscal year, which ends in June, Microsoft said that sales should be between $44 billion and $44.5 billion, in line with analyst's consensus estimate of $44.2 billion. The company added that earnings, excluding the second-quarter tax benefit and a first-quarter charge for a legal settlement, should be in a range of $1.29 a share to $1.32 a share. Wall Street is expecting earnings of $1.32 a share.

The company also continued to be an aggressive buyer of its own stock during the second quarter, repurchasing $7.4 billion's worth of shares. Microsoft has been buying back stock in order to increase shareholder value, as a reduced share count boosts earnings per share.

Microsoft finished the end of December with $34.7 billion in cash on its balance sheet.

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Soleil's Friedman owns shares of Microsoft but has firm has no banking ties with the company. The other analysts quoted in this piece do not own the stock and their firms have not done investment banking for Microsoft. Top of page

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