Microsoft's News of Many Parts

Components shortages crimped Xbox sales, but Redmond's latest numbers and projections were more than enough to buoy investors' spirits

For investors, Microsoft's (MSFT) fiscal second-quarter results inspired equal doses of relief and optimism. Wall Street was bracing for tepid sales of Microsoft's new Xbox 360 game console. The software giant earlier had said it was having difficulty obtaining key components, making it hard to meet demand.

The relief came when Microsoft said sales of the console came in better than the most pessimistic Wall Street expectations. Some saw the software giant selling 1.3 million units, down from as many as 1.8 million before the component shortfall was disclosed (see BW Online, 10/28/05, "Microsoft's Xbox Factor"). In the end, Microsoft sold 1.5 million. Optimism stemmed from Microsoft's upbeat outlook for the rest of the year as it prepares to launch new versions of its two most important products – Windows and Office.


  The quarter itself was fairly unspectacular. Microsoft earned $3.65 billion, a 5.5% gain from a year earlier, on sales of $11.8 billion -- a 9.4% jump. While the earnings number was in line with the Redmond's previous guidance, the sales number came in about $100 million light. Microsoft blamed that shortfall on Xbox 360. It pointed to shortages of a handful of different components.

Microsoft declined to specify which parts caused the problem, but said the challenge was largely the result of launching a hot-selling product to a worldwide audience. "It's not surprising from our perspective," Microsoft Chief Financial Officer Chris Liddell said during a conference call with analysts. More important, he added that the issues were not systemic.

Still, Microsoft backed off earlier projections that it would sell 2.75 million to 3 million consoles in the first 90 days. It trimmed that guidance to 2.5 million units. But the company says it remains on track to sell between 4.5 million and 5.5 million consoles by June 30, the end of its fiscal year.


  The growth engine for Microsoft in the second quarter, as it has been for the last several quarters, was its server software business. Sales from that group jumped 14% to $2.9 billion. The big gain came from Microsoft's SQL Server database software, which launched a new version in the quarter.

The two biggest businesses -- Windows and Office – posted modest growth. The Windows business grew 8% to $3.5 billion, on higher-than expected consumer sales. For the quarter, Microsoft estimates that overall PC sales jumped 14% to 15%. That also buoyed Microsoft's Information Worker unit, where revenue is largely comprised of Office sales. That business gained 5% in the quarter, posting $3 billion in sales.

Liddell remained bullish on Microsoft's other products for the rest of the fiscal year and into fiscal 2007. "We expect overall IT spending to remain healthy for the entire year," Liddell said. For the third quarter, he expects Microsoft sales to climb 13% to 16% from the previous year, with earnings growing 11% to 13% after excluding a one-time legal settlement from the previous year. For the year, sales should increase by 11% to 12%, while earnings will increase 10% to 12%, minus the one-time charge.


  With the promise of consecutive double-digit growth in revenue and earnings, the stock rose in extended trading to $27.10, up a total of 70 cents on the day.

All of this is in advance of the launches of new versions of Windows and Office, expected in the second-half of 2006. "As the year progresses, the stock will build its multiple," says Goldman Sachs analyst Rick Sherlund, who thinks the price could hit $32 over the next year.

Growth in the low-teens may not be the Microsoft of old. But for a mature company, it's enough to get investors anticipating good times ahead.

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