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An IT Spending Boost for Microsoft

Adding to the chorus hailing the return of corporate tech spending, Microsoft (MSFT) posted fiscal third-quarter results on Apr. 22 that blew past analysts' expectations. The world's largest software company reported huge gains in its three core businesses: the Windows operating system, the Office productivity suite, and server software, all a direct result of growing corporate spending.

"Our results this quarter demonstrate that we're in the midst of a corporate recovery," Microsoft Chief Financial Officer John Connors says. "Corporate profits are up, and businesses seem more willing to invest in IT projects."

That translated into big gains for Gates & Co. Sales jumped 17%, to $9.18 billion in the quarter. Analysts had been expecting revenues to come in closer to $8.66 billion. Earnings fell 38%, to $1.32 billion, largely the result of charges related to settling a private antitrust suit filed by Sun Microsystems (SUNW) and setting aside money to pay a fine imposed by the European Commission for anticompetitive conduct.

WINNING WARHORSES. Subtract those charges, and another for stock-based compensation, and Microsoft would have earned 34 cents a share, vs. 26 cents a share for the same quarter a year ago, and the 29 cents a share that analysts had expected.

Microsoft's old warhorses -- Windows, Office, and the server-software unit -- posted larger gains than even the company expected. Sales of the PC operating system jumped 16% in the quarter, to $2.9 billion, as Windows XP Professional, which costs more than the Home version, accounted for 58% of the total Windows sales. Sales of the Office products grew 18% in the quarter, to $2.7 billion, as strong upgrade sales continue from the launch of Office 2003 last October. And Microsoft's server-software business climbed 19%, to $2.2 billion, as its sales continue to outpace the overall market's growth rate.

What's more, Microsoft bumped up its expectations for the year. Sales should grow from 13% to 14%, or from $36.4 billion to $36.5 billion, above analysts' expectations of $35.9 billion. "We had a fantastic quarter, and we're going to have a great year," Connors says.

DROOPY 'O5. Still, troubles loom. Analysts had projected that Microsoft's fiscal 2005 revenue would grow merely 7%. Now the company says sales won't even hit that mark. Connors told analysts to expect next year's sales to come in between $37.8 billion and $38.2 billion, an anemic 4% growth rate over the now-higher projections for fiscal 2004.

Why the slowdown? Connors says Microsoft will have "tough comparables" in some businesses, particularly the Office franchise, which is performing so strongly this year. Xbox poses another sales challenge, as the game console approaches the end of its life cycle. Introduced in 2001, Xbox, like its rivals from Sony (SNE) and Nintendo (NTDOY), is beginning to run out of steam. To generate new sales, Microsoft recently cut Xbox' price from $179 to $149.

And Connors shed no new light on one issue that investors are waiting to get resolved: What will Microsoft do with its huge cash reserve? That hoard grew to an eye-popping $56.4 billion. Shareholders have pressed Microsoft to give a chunk of it back in the form of a higher dividend or a significant stock buyback. For the last year, Microsoft said it would keep the cash in the event that a ruling in the European antitrust matter or the Sun case would fundamentally alter its business model.

It seems as though that won't happen, but Connors would say only that Microsoft will address the topic before its annual financial analysts meeting in June. By Jay Greene in Seattle

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