Earnings: PC demand helps Microsoft beat forecast

Xbox 360 shortages frustrated gamers during the holiday season, but they apparently had little effect on Microsoft's bottom line.

Strong sales of PC software and business products offset the Xbox situation, and overall sales rose 9 percent in the quarter that ended Dec. 31, the company reported Thursday.

It was apparently the report investors had been waiting to hear from Microsoft, which had a rare stock rally this morning. Shares rose $1.29, or 4.9 percent, to close at $27.79.

Microsoft also stepped up hiring, increasing its work force 13 percent to prepare for a series of new product releases.

It wouldn't provide its headcount yesterday, but as of Sept. 30 the company employed 30,255 locally and 63,564 globally.

At $11.8 billion, sales were less than the $11.9 billion Microsoft had forecast in October. Operating income fell 2 percent as the company spent heavily on several product launches.

Yet net profit was up 5 percent to $3.65 billion, or 34 cents a share, a penny better than Wall Street analysts surveyed by Thomson Financial expected.

Some had braced for worse news about the Xbox 360, which went on sale Nov. 22. Microsoft reported selling 1.5 million consoles in the quarter.

"The Street breathed a sigh of relief," said Goldman Sachs analyst Rick Sherlund, who expected Microsoft to report 1.3 million console sales.

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After the earnings were released Thursday, Microsoft stock rose in after-hours trading. During regular Thursday trading, the stock closed at $26.50, up 10 cents, then rose to $27.01 in extended trading.

Component-supply issues and challenges ramping up production have limited output, Chief Financial Officer Chris Liddell said. Microsoft now expects to ship 2.5 million video-game consoles in the product's first 90 days, down from its earlier goal of 2.75 million to 3 million units.

A third manufacturer added recently will help Microsoft reach its Xbox targets of 4.5 million to 5 million units in the fiscal year, Liddell said.

"It's a few hundred thousand less," he said during an interview. "We expect to make those up by the time June 30 comes around."

Liddell also noted that since the product went on the market, customers have spent $1.5 billion on the console, games and peripherals, "which is indicative of the health and magnitude of the Xbox 360 launch."

Another one of Microsoft's new businesses — its mobile-phone software group — also fared well in the quarter. The mobile and embedded-devices business posted its first operating profit, $20 million, after launching a new version of its Windows Mobile software.

Microsoft's midsize-business group also turned an operating profit — $10 million. Sales rose 17 percent after the group released a new version of its customer-relationship management software.

But Microsoft's quarter was carried by its bread-and-butter products, especially as consumers around the world bought millions of PCs.

PC sales grew 14 to 15 percent, boosting Windows sales by 8 percent, to $3.46 billion, and productivity-software sales up 5 percent, to $2.98 billion.

Businesses also bought a lot of technology in the quarter, at least from Microsoft. Its server and tools group sales rose 14 percent, to $2.9 billion, driven by the release of a new SQL database and Visual Studio programming toolkit.

Retooling and product-development costs took a toll on the performance of the MSN group, which reported a 2 percent decline in sales and 55 percent decline in operating profit.

The group is cutting back on its Internet subscription business and gearing up to challenge Google with a new advertising-sales platform, adCenter, now being tested in the U.S.

MSN ad sales grew 12 percent, or $40 million, but its search advertising sales fell 20 percent as the switchover to adCenter began. The group expects its profitability decline to continue through the fiscal year that ends June 30 as it invests in new applications and services.

Use of MSN services has grown, however. Hotmail accounts increased in the quarter to 230 million from 191 million, and MSN Messenger accounts grew to 205 million from 156 million from a year earlier.

Microsoft stepped up its stock-buyback program, buying $7.67 billion worth of its stock during the quarter.

For the quarter ending March 31, Microsoft expects sales of $10.9 billion to $11.2 billion and earnings per share of 32 to 33 cents. For the fiscal year, it expects sales of $44 billion to $44.5 billion — up a bit from October's forecast of $43.7 billion to $44.5 billion.

It now expects profit for the year to be $1.28 to $1.31 per share, compared with October's forecast of $1.26 to $1.30.

JPMorgan analyst Adam Holt said the key for Microsoft is going to be sales growth expected from new products such as Windows Vista and the new version of Office set to go on sale in late 2006.

For now, the company's performing "in line" with expectations, Holt said.

"Xbox was disappointing but this was largely telegraphed and in aggregate, I thought it was in-line to modestly better than expected results."

Brier Dudley: 206-515-5687 or bdudley@seattletimes.com